I don’t dislike Electronic Arts Inc. (NASDAQ:EA) stock. There’s an intriguing long-term case for the video game industry as a whole. EA stock has been an outstanding investment over time. And while Electronic Arts isn’t necessarily cheap, it still has the ability to grow into its valuation over time.
Indeed, I recommended EA stock back in December. But with EA up double digits since then, and some concerns on the near-term horizon, I don’t see EA as all that compelling at the moment.
Certainly, Electronic Arts could change my mind. Growth should accelerate toward the second half of the year and into 2019. But a 22x+ forward P/E multiple — even backing out the company’s $10+ per share in net cash — just isn’t low enough to get excited about. And I see EA stock as a bit of a “show me” story ahead of earnings next month.
Two Concerns Facing EA Stock
With EA earnings due on May 8, there are two key concerns that could hit the stock into, and out of, that report.
The first is the health of EA’s Star Wars Battlefront II. I wrote ahead of the fiscal Q3 report in January that Battlefront had turned EA into a battleground stock. Electronic Arts stock would jump after the report — then give back the gains amid a plunging broad market.
In other words, the argument wasn’t settled by the Q3 results. With Electronic Arts last month making major changes, including the permanent removal of “loot boxes,” the debate probably gets punted to the Q4 report. No doubt, investors will be closely monitoring engagement with Battlefront II in the wake of what turned out to be a relatively controversial launch.
The emphasis on Battlefront may be amplified by the continuing popularity of Fortnite. That multiplayer game from privately held Epic Games has turned out to be a major hit. And the huge amount of interest has impacted video game stocks, most notably Take-Two Interactive Software, Inc (NASDAQ:TTWO), as Luke Lango detailed this month.
Whether Fortnite creates a buying opportunity in the space is up for debate. (James Brumley made that case on this site last week.) But combined with concerns about Battlefront II, it does seem to set up an important earnings report for Electronic Arts stock.
Is Electronic Arts Stock Cheap Enough?
EA bulls probably would argue that the potential concerns facing Q4 earnings are just short-term noise. And that’s probably the case. At the least, even a wobbly Q4 report wouldn’t change the long-term tailwinds behind Electronic Arts stock.
And there are real tailwinds here. The category continues to grow, as new customers age in and older customers stick around, as Bret Kenwell pointed out. Even with the end of “loot boxes,” in-game monetization revenues are growing and will continue to grow.
And digital downloads help margins for video game makers, a key reason why GameStop Corp. (NYSE:GME) stock keeps falling while EA, TTWO and Activision Blizzard, Inc. (NASDAQ:ATVI) grind higher.
But price matters, too. And back at $125, I’m not sure EA’s price is all that compelling. A low 20s forward P/E multiple isn’t that onerous, but this also is a company expecting maybe 4% revenue growth this year.
Core sports franchises like Madden and UFC aren’t going to post torrid year-over-year growth. Long term, Electronic Arts seems likely to deliver steady, but not necessarily spectacular, earnings growth.
At these levels, that looks roughly priced in. And were I more bullish on EA stock, I’d certainly be hoping that the short-term concerns offer a more attractive entry point.
But $125 isn’t a terrible price for Electronic Arts stock, and I’d rather own EA than ATVI or social-gaming plays like Zynga Inc (NASDAQ:ZNGA). But TTWO, which is down ~7% YTD, looks more attractive, and I’m not thrilled about paying 22x forward earnings for EA stock.
It’s true that Electronic Arts is likely to post years of growth, but that’s no secret. And unless that growth is better than expected or EA stock gets cheaper, I’m not sure I see a huge edge in jumping in with both feet.
As of this writing, Vince Martin has no position in any securities mentioned.
