Video game publisher Electronic Arts (NASDAQ:EA) reported strong first-quarter numbers that topped expectations on the top and bottom lines. A light full-year sales guide, however, dinged investor confidence. As of this writing, EA stock is down about 6% in response to those numbers, increasing the stock’s slide to over 10% in the past few days.
This isn’t terribly surprising. I wrote a piece going into earnings about how EA stock wasn’t a buy before earnings, despite having a great long-term story. The rationale was that EA stock had come too far, too fast. The price tag had sprinted ahead of fundamentals in the near-term. Consequently, any weakness in the report would result in a selloff.
We got that selloff in EA stock. Now what? Wait for the weak hands to shake out. Wait for this recent market volatility to settle down. And then, come in and buy the dip on EA stock.
Here’s a deeper look.
EA’s Quarter Was Good, But Not Good Enough
Here’s the problem with EA’s quarter: it was more of the same good stuff, but nothing more. EA stock was trading at 30X forward earnings into the report versus a five-year average forward multiple of 23. Thus, the stock naturally needed “more than usual” to get a boost.
The company didn’t report “more than usual.” It reported the usual and EA stock naturally dropped.
The digital revolution continues to be strong. Digital net bookings rose 13% year-over-year, and now comprise 69% of total bookings. But, it looks like the big margin boost from the digital shift is now in the rear-view mirror as outsized gross margin expansion over the past several years is expected to moderate this year.
The World Cup provided a nice lift to the FIFA gaming world, and also underscored this company’s promising potential in eSports. The World Cup content update in the quarter had 15 million unique players. Moreover, and more importantly, the company’s FIFA eSports league has 20 million participants, and viewership is up 80% year-over-year.
Beyond strong digital growth and a nice World Cup lift, the quarter didn’t have much to write home about. Revenue growth trends remain in line with historical norms of around 8% to 9%. Gross margins remain healthy, but outsized gains appear to be in the rear-view mirror. And cash flow growth continues to grow at a steady 8% rate.
In other words, EA’s quarter was good but it wasn’t good enough to support a 30X multiple on EA stock. As such, EA stock is dropping.
An Opportunity Will Present Itself Soon
Long-term, EA stock looks like a solid multiyear investment.
The company is at the heart of three secular shifts in the video game industry, all three of which materially benefit EA’s business. Those three shifts are:
- Traditional gaming to AR/VR gaming, which will grow gamer engagement and mass consumer interest in EA video games.
- Legacy model to subscription model, which will lead to more predictable and higher-margin revenues.
- Isolated gaming to eSports, which will grow consumer awareness and create new revenue opportunities through advertising and partnerships.
Put these three shifts together, and it is easy to see why EA stock can be a big winner over the next several years. Consequently, this recent sell-off should be viewed as an opportunity to buy the dip.
But not just yet.
By my numbers, EA stock is still slightly overvalued here and now. I think 8% revenue growth per year and slight margin expansion over the next five years will drive earnings per share to around $8. A historically average 23X forward multiple on that implies a four-year forward price target of $184 on EA stock. Discounted back by 10% per year, that equates to a present value in the upper $120’s.
Thus, at $135, the price tag still seems slightly ahead of fundamentals.
Plus, the market is somewhat of a mess right now. Facebook’s (NASDAQ:FB) big earnings drop has caused panic across many hyper-growth names, EA stock included. Thus, I think investors can afford to wait for this noise to pass before buying the dip on EA.
Bottom Line on EA Stock
This is a name you want to own for the next several years. But buying more now seems a little premature. Let EA stock come down a bit more, and let the volatility settle, before buying the dip on EA stock.
As of this writing, Luke Lango was long EA.
“Financial Anomaly” to Trigger Windfall Profits
As you read this, a rare set of events has created what we believe will become one of the three biggest investment opportunities of your life, no matter when you were born.
This “financial anomaly” could a trigger a financial boom that will hand investors 10x gains … 20x gains … even some 50x gains.
This boom will take place in the legal marijuana business.
If you missed the opportunity to make 50 times your money in internet stocks … or if you missed out on the opportunity to make 50 times your money in bitcoin, you’re going to want to know exactly what’s going on here.
