How to Trade Electronic Arts Inc. (EA) Stock After Earnings

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EA Stock - How to Trade Electronic Arts Inc. (EA) Stock After Earnings

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If there’s one group that’s been on fire this year but doesn’t seem to get nearly enough credit, it’s video games. Electronic Arts Inc. (NASDAQ:EA), Take Two Interactive Software Inc (NASDAQ:TTWO) and Activision Blizzard, Inc. (NASDAQ:ATVI) have rallied hard. Let’s put it this way, EA stock is the worst performer of the three and it’s up a whopping 47% in 2017.

After the close today, Electronic Arts will report earnings. Investors are likely wondering what they should do. Buy, sell or hold into the report? The answer, as usual, depends on when investors bought into EA stock (if they’re long) and what their risk tolerance. More on that below.

The video game industry has some strong tailwinds behind it right now. Sales are strong and the operating environment couldn’t be better. Investors were once hesitant that more advanced technology would destroy the value of game makers. Instead, it’s done anything but.

The industry is heading into the second half of the year, which is historically stronger than the first half. Advancements in technology have allowed for video game downloads, which at one point created fear that this would steer people to downloading and sharing games as they would MP3 files.

But that hasn’t been the case. Video game downloads are instead driving wider margins and higher sales as consumers download more titles and game makers realize a lower overhead from not having to package all their content physically and with a thick manual.

Adding to that point, the digital download space has created another margin booster: In-game purchases. By allowing consumers to seamlessly buy new levels, equipment, decals and other products for in-game use — usually in the $3 to $12 range — these are bread-and-butter margin boosters.

Expectations for EA Stock

Analysts expect Electronic Arts to earn 27 cents per share on $768.5 million in revenue. If management meets expectations, it would represent an impressive 285% growth in year-over-year earnings and 12.7% sales growth. Just three months ago, analysts only expected earnings per share of 19 cents, more than 40% below current estimates.

That’s a big increase in expectations and you know what they say: The bigger they are, the harder they fall.

Now I’m not saying I think EA will strike out and plummet when it reports earnings. I’m just saying that as analyst expectations increase, as do investors’ expectations. When that happens, the stock tends to rally in anticipation of good results. Should those good results come, the stock can have a muted reaction even on a good report. But a bad report could send shares tumbling.

Put simply: As estimates increase and the stock rallies, the risk-reward shifts out of our favor.

While robust growth is expected this quarter, the same cannot be said for the full year. At least not yet. Analysts only expect sales growth of 7.8% in 2017. An acceleration to 13.3% in 2018 is more attractive, though. On the earnings front, just 7.4% growth in 2017 is again, not so great. But in 2018 that’s forecast to accelerate to 18.7% growth.

The upside to EA stock is that secular trends favor the video game sector. The downside, at least right now, is valuation: 7.4% earnings growth is good and 18.7% in 2018 is great … but a price-earnings ratio of 37 and a forward P/E of 22.7 is still too high.

Trading EA Stock

EA stock, Electronic Arts, EA, EA earnings
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Source: Stockcharts.com

EA stock has been squarely trading within a tight range of $105 to $115. This consolidation, at least on the surface, is bullish in my view.

The stock broke out from the mid-$90s into this range and has found support several times at $105. The bullish thesis would have investors hoping for a breakout over $115.

But “hoping for a breakout” is part of the problem. I would rather buy a breakout over $115 and miss some of the upside than buy at $113.66 ahead of earnings and “hope” it breaks above. The risk is too great for me.

Perhaps if EA stock had a lower valuation, it would be more tempting on the long side. Or if shares were trading at the bottom of its recent range near $105.

So how do investors play it? For those looking to go long, look for a pullback first. If $105 holds as support, EA stock is a buy. Likewise, if it breakouts over $115, investors can buy EA and use that level as a stop-loss moving forward. Look for prior resistance ($115) to act as support if this happens.

This is a reactionary trade, rather than a predictive one. Wait for earnings before taking a shot. Either shares break out or break down. We’ll know which one after earnings and if a trade develops as a result.

Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell did not hold a position in any of the aforementioned securities.

Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell.


Article printed from InvestorPlace Media, https://investorplace.com/2017/07/how-to-trade-electronic-arts-inc-ea-stock-after-earnings/.

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