Electronic Arts Inc.'s (NASDAQ:EA) price-to-earnings (or "P/E") ratio of 36.8x might make it look like a strong sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 16x and even P/E's below 9x are quite common. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the highly elevated P/E.
Recent times have been pleasing for Electronic Arts as its earnings have risen in spite of the market's earnings going into reverse. It seems that many are expecting the company to continue defying the broader market adversity, which has increased investors' willingness to pay up for the stock. If not, then existing shareholders might be a little nervous about the viability of the share price.
View our latest analysis for Electronic Arts
What Are Growth Metrics Telling Us About The High P/E?
Electronic Arts' P/E ratio would be typical for a company that's expected to deliver very strong growth, and importantly, perform much better than the market.
If we review the last year of earnings growth, the company posted a worthy increase of 13%. Ultimately though, it couldn't turn around the poor performance of the prior period, with EPS shrinking 19% in total over the last three years. So unfortunately, we have to acknowledge that the company has not done a great job of growing earnings over that time.
Turning to the outlook, the next three years should generate growth of 17% each year as estimated by the analysts watching the company. With the market only predicted to deliver 12% each year, the company is positioned for a stronger earnings result.
With this information, we can see why Electronic Arts is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Key Takeaway
Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.
We've established that Electronic Arts maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. Unless these conditions change, they will continue to provide strong support to the share price.
Before you settle on your opinion, we've discovered 1 warning sign for Electronic Arts that you should be aware of.
If you're unsure about the strength of Electronic Arts' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
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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.