In late April, I laid out five big reasons why Electronic Arts (NASDAQ:EA) was positioned to rally to $125 in 2020. Since then, EA stock has traded largely sideways around the $115 level amid broader market turbulence and a lousy fourth quarter earnings report from the company.
Investors shouldn’t be too concerned with this recent chop.
The long-term growth drivers underlying EA’s report remain robust. Video game sales and engagement are rising. EA continues to release hit new games in its franchise verticals. Esports interest and viewership is rising. And EA stock is still fairly valued.
All in all, the stock is still positioned to hit $125 in 2020, and head materially higher in subsequent years, on back of favorable long-term growth drivers.
As such, I’d stick with EA stock, and buy on any big dips in the near future.
A Winning Company in a Winning Space
In the big picture, EA is a winning company in a winning space.
The video game market is ripe for huge growth over the next decade for various reasons, including:
- Personal video game engagement should continue its secular rise, amid broader social digitization trends, which have only accelerated thanks to the novel coronavirus pandemic.
- The commercial launch of 5G should improve all technology aspects of gaming, from better graphics to more AR/VR features to increased cloud gaming capability, and everything in between. All of these technological improvements boost engagement.
- A rise in consumer awareness of pro gaming leagues, coupled with technological improvements advancing streaming quality, should enable the esports market to sustain robust viewership growth over the next few years, laying the groundwork for video game publishers to generate meaningfully large ad revenue streams.
All in all, the video game market will boom in the 2020’s.
EA will sustain a leadership position in that booming market, mostly because the company is supported by a robust portfolio of gaming franchises with enduring appeal (like FIFA and Madden), and because many of the company’s most-played titles (again, like FIFA and Madden) are competitive games that lend themselves well to turning into huge esports leagues.
Net net, EA and the whole video game market will win big over the next several years.
Attractive Long-Term Upside Potential
Under realistic growth assumptions, EA stock should be able to rally towards $200 within the next few years.
The math is pretty simple. The video game market should sustain mid-to-high single-digit revenue growth for the next several years, supported by increasing engagement, technological improvements and new esports advertising revenue. EA should sustain its market share in that growing market, and similarly grow revenues at a mid-to-high single-digit compounded annual growth rate going forward.
Gross margins should remain relatively stable around 45%. Increased in-game spending from consumers plus a broad shift towards higher-margin cloud gaming should decrease the opex rate, and drive meaningful net profit margin expansion.
Mid-to-high, single-digit revenue growth plus meaningful margin expansion should produce approximately 10% profit growth into 2025. Assuming so, my modeling suggests EA’s earnings per share will wind up around $8 by 2025.
EA stock normally trades at 23-times forward earnings. Based on that average forward multiple, $8 in 2025 earnings per share implies a 2024 price target for EA stock of $184.
Discounted back by 10% per year, that equates to a 2020 price target of roughly $125.
Bottom Line on EA Stock
The red-hot rally in EA stock this year has been put on pause over the past few weeks. This pause won’t last long. The stock is just taking a breather after a big run over a short period. Let shares consolidate here. Then let the stock run to new highs over the next few years, on the back of favorable long-term growth drivers. Also consider buying Activision (NASDAQ:ATVI) and Take-Two (NASDAQ:TTWO) on any material weakness going forward.
Video game stocks are broadly due for a strong future.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he did not hold a position in any of the aforementioned securities.
