Yahoo Finance Is Electronic Arts Inc (NASDAQ:EA) Attractive At This PE Ratio?
This article is intended for those of you who are at the beginning of your investing journey and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
Electronic Arts Inc (NASDAQ:EA) trades with a trailing P/E of 46, which is higher than the industry average of 20.3. Although some investors may see this as unappealing, it is important to understand the assumptions behind the P/E ratio before making judgments. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
Check out our latest analysis for Electronic Arts
Breaking down the Price-Earnings ratio
A common ratio used for relative valuation is the P/E ratio. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for EA
Price-Earnings Ratio = Price per share ÷ Earnings per share
EA Price-Earnings Ratio = $103.6 ÷ $2.252 = 46x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to EA, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. EA’s P/E of 46 is higher than its industry peers (20.3), which implies that each dollar of EA’s earnings is being overvalued by investors. This multiple is a median of profitable companies of 23 Entertainment companies in US including Chicken Soup for the Soul Entertainment, Dolphin Entertainment and Viacom. You could think of it like this: the market is pricing EA as if it is a stronger company than the average of its industry group.
A few caveats
Before you jump to conclusions it is important to realise that there are assumptions in this analysis. The first is that our “similar companies” are actually similar to EA. If not, the difference in P/E might be a result of other factors. Take, for example, the scenario where Electronic Arts Inc is growing profits more quickly than the average comparable company. In that case, the market may be correct to value it on a higher P/E ratio. We should also be aware that the stocks we are comparing to EA may not be fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to EA. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for EA’s future growth? Take a look at our free research report of analyst consensus for EA’s outlook.
Past Track Record: Has EA been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of EA’s historicals for more clarity.
Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
