Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after briefly looking over the numbers, we don’t think Electronic Arts (NASDAQ:EA) has the makings of a multi-bagger going forward, but let’s have a look at why that may be.
Return On Capital Employed (ROCE): What is it?
For those who don’t know, ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Electronic Arts:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.11 = US$1.1b ÷ (US$13b – US$2.6b) (Based on the trailing twelve months to September 2021).
So, Electronic Arts has an ROCE of 11%. That’s a pretty standard return and it’s in line with the industry average of 11%.
In the above chart we have measured Electronic Arts’ prior ROCE against its prior performance, but the future is arguably more important. If you’d like to see what analysts are forecasting going forward, you should check out our free report for Electronic Arts.
The Trend Of ROCE
In terms of Electronic Arts’ historical ROCE movements, the trend isn’t fantastic. Around five years ago the returns on capital were 21%, but since then they’ve fallen to 11%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
On a related note, Electronic Arts has decreased its current liabilities to 20% of total assets. That could partly explain why the ROCE has dropped. What’s more, this can reduce some aspects of risk to the business because now the company’s suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business’ efficiency at generating ROCE since it is now funding more of the operations with its own money.
The Bottom Line On Electronic Arts’ ROCE
While returns have fallen for Electronic Arts in recent times, we’re encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has followed suit returning a meaningful 61% to shareholders over the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
If you’d like to know about the risks facing Electronic Arts, we’ve discovered 2 warning signs that you should be aware of.
While Electronic Arts isn’t earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.