There are a few key trends to look for if we want to identify the next 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Electronic Arts (NASDAQ:EA) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Electronic Arts is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = US$1.5b ÷ (US$13b - US$2.8b) (Based on the trailing twelve months to September 2023).
Thus, Electronic Arts has an ROCE of 15%. On its own, that's a standard return, however it's much better than the 9.6% generated by the Entertainment industry.
View our latest analysis for Electronic Arts
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.
So How Is Electronic Arts' ROCE Trending?
The trend of ROCE doesn't look fantastic because it's fallen from 19% five years ago, while the business's capital employed increased by 52%. Usually this isn't ideal, but given Electronic Arts conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. Electronic Arts probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt. Also, we found that by looking at the company's latest EBIT, the figure is within 10% of the previous year's EBIT so you can basically assign the ROCE drop primarily to that capital raise.
Our Take On Electronic Arts' ROCE
Bringing it all together, while we're somewhat encouraged by Electronic Arts' reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 60% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
If you want to continue researching Electronic Arts, you might be interested to know about the 1 warning sign that our analysis has discovered.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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.