Benjamin Graham taught that Intelligent Investors must do a thorough fundamental analysis of investment opportunities to determine their intrinsic value and inherent risk. Â This isÂ best done by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another companyÂ or by reviewing theÂ 5 Most Undervalued Companies for the Defensive Investor – January 2015.Â By using theÂ ModernGraham methodÂ one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries. Â What follows is a specific look at how Electronic Arts Inc. (EA)Â fares in theÂ ModernGraham valuation model.
Company ProfileÂ (obtained fromÂ Google Finance):Â Electronic Arts Inc is a game software content and services provider. The Company develops, markets, publishes and distributes game software content for consumers of various video game machines and electronic devices. It also provides game software-related services. The Companyâ€™s brands include Battlefield, Mass Effect, Need for Speed, Dragon Age, The Sims, Bejeweled and Plants v. Zombies, as well as brands based on licensed intellectual property such as FIFA, Madden NFL and Star Wars. The Company is organized around three divisions: EA Studios, Maxis and EA Mobile. The EA Studios division develops games and related content and services across a range of game categories, including the FIFA, Madden NFL, Need for Speed, Battlefield, Mass Effect and Dragon Age. The Maxis division creates games, and related content and services that engage player creativity. The EA Mobile division focuses on developing and publishing interactive games for mobile phones and tablets.
Defensive Investor – must pass at least 6 of the following 7 tests: Score = 1/7
- Adequate Size of Enterprise – market capitalization of at least $2 billion -Â PASS
- Sufficiently Strong Financial Condition – current ratio greater than 2 -Â FAIL
- Earnings Stability – positive earnings per share for at least 10 straight years -Â FAIL
- Dividend Record – has paid a dividend for at least 10 straight years -Â FAIL
- Earnings Growth – earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period -Â FAIL
- Moderate PEmg ratio – PEmg is less than 20 -Â FAIL
- Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 -Â FAIL
Enterprising Investor – must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 2/5
- Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 -Â FAIL
- Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1 -Â PASS
- Earnings Stability – positive earnings per share for at least 5 years -Â FAIL
- Dividend Record – currently pays a dividend -Â FAIL
- Earnings growth – EPSmg greater than 5 years ago -Â PASS
|Value Based on 3% Growth||$12.05|
|Value Based on 0% Growth||$7.07|
|Market Implied Growth Rate||28.75%|
|Net Current Asset Value (NCAV)||$0.85|
Balance Sheet – DecemberÂ 2014
Earnings Per Share
Earnings Per ShareÂ – ModernGraham
Electronic Arts does not pay a dividend.
Electronic ArtsÂ is not suitableÂ for either the Defensive Investor or the Enterprising Investor. Â The Defensive Investor is concerned with the low current ratio, insufficient earnings growth or stability over the last ten years, lack of dividends, and the high PEmg and PB ratios. Â The Enterprising Investor is concerned with the current ratio, lack of dividends, and the lack of earnings stability over the last five years. Â As a result, value investorsÂ following the ModernGraham approach based on Benjamin Graham’s methods should exploreÂ other opportunities. Â As for a valuation,Â the company appears to be overvaluedÂ after growingÂ its EPSmg (normalized earnings) from a loss of $1.69 in 2011 to an estimated gain of $0.83 for 2015. Â While very strong, this level of growth does not support the market’s implied estimate of 28.75% growth, leading the ModernGrahamÂ valuation model, based on Benjamin Graham’s formula, to return an estimate of intrinsic value well belowÂ the price.
Be sure to check out previous ModernGraham valuations of Electronic Arts Inc. (EA)Â for greater perspective!
The next part of the analysis is up to individual investors, and requires discussion of the company’s prospects. Â What do you think? Â What value would you put on Electronic Arts Inc. (EA)? Â Where do you see the company going in the future? Â Is there a company you like better? Â Leave aÂ comment on ourÂ Facebook pageÂ or mentionÂ @ModernGrahamÂ on Twitter to discuss.
Disclaimer: Â The author did not hold aÂ position in Electronic Arts Inc. (EA)Â at the time of publication and had no intention of changing that position within the next 72 hours. Â Logo taken from Wikipedia for the sole purpose of identifying the company; this article is not affiliated with the company in any manner.