Calendar 2020 has brought with it ample change to the world. One of those changes is that, thanks to the novel coronavirus pandemic, consumers are staying at home more and playing video games more often. Naturally, this has provided a huge tailwind for all video game stocks, Electronic Arts (NASDAQ:EA) stock included.
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Year-to-date, EA stock is up 30%.
Some investors are concerned this rally is on its last legs. They cite an extended valuation — shares trade at 27 times forward earnings, versus a five-year-average forward earnings multiple of 23x — and technical resistance — EA stock topped out around $150 in 2018 — as reasons why the best of this rally has already happened.
They are right. To an extent. EA stock won’t rally another 30% over the next six months. The best of the rally has already happened.
But this rally isn’t over. Far from it.
Instead, EA stock has ample firepower to keep powering higher at a steady pace for the rest of the year.
Strong Macro Fundamentals
EA stock can and will stay in rally mode for the foreseeable future, mostly because the fundamentals underlying the company and the entire video game industry will broadly improve over the next several months and years.
Zooming out, the video game industry has been on a secular uptick over the past several years, as consumers have increasingly digitized their interactions and the industry has expanded its reach into the mobile arena.
This industry, however, is on the cusp of meaningfully accelerating in the early 2020s, thanks to:
- New console launches, including a new Xbox and new Playstation console in late 2020, and a new Switch console in 2021.
- The standardization of 5G technology, which will enable breakthroughs in cloud gaming, AR/VR capability and mobile gaming.
- Continued growth in the esports vertical, powered by 5G-driven improvements in streaming quality and a rise in consumer awareness as more and more leagues make their way onto ESPN, ABC and the like.
- Continued growth in console-quality, free-to-play battle royale games like Fortnite.
Strong Micro Fundamentals
Electronic Arts, thanks to its robust and diversified portfolio of rich gaming content, is well positioned to capitalize on all these growth opportunities.
Between FIFA, Madden, The Sims, Star Wars, and Apex: Legends, EA’s content portfolio is wide enough, rich enough and diverse enough to sustain enduring popularity and demand amid rising video game engagement and sales over the next few years.
More than that, FIFA and Madden are perfect titles for esports. Indeed, EA today is aggressively expanding its FIFA esports leagues.
Meanwhile, The Sims is about to turn into a reality TV show. Management has a huge opportunity to build on the success of Star Wars: Galaxy of Heroes and develop a robust mobile-oriented Star Wars gaming pipeline. Apex: Legends is one of the market’s leading free-to-play battle royale franchises, and it’s latest season is off to a record start.
In other words, Electronic Arts is on fire. At a time when the video game market is on the cusp of accelerated growth.
That’s a winning combination for EA stock.
The only thing that could really slow EA stock at this point in time is valuation.
But valuation friction presently isn’t intense enough to stop the red-hot rally.
Because EA’s favorable growth drivers should persist for the next several years, the company reasonably projects to grow revenues at a steady mid-single-digit or better pace into 2025. Alongside that steady revenue growth, gross margins should improve thanks to a pivot towards software-backed cloud gaming, which should carry higher margins. Economies of scale should also drive mildly positive operating leverage.
Net net, you’re talking about a company that should be able to sustain 10%+ profit growth into 2025.
Assuming so, $10 in earnings per share is a doable target for EA by 2025.
Based on a historically average 23x forward earnings multiple and a 10% annual discount rate, that implies a 2020 price target for EA stock of nearly $160.
Bottom Line on EA Stock
The video game market is on the cusp of accelerated growth in the early 2020s, thanks to new console launches, the roll-out of 5G and a continued rise in esports and free-to-play genre popularity.
That might also explain the recent fund flows into several of the exchange-traded funds following this industry, including VanEck Vectors Video Gaming and eSports ETF (NASDAQ:ESPO) and Global X Video Games & Esports ETF (NASDAQ:HERO). Both include EA stock among their portfolios’ top 10 holdings.
Against that backdrop, Electronic Arts is firing on all cylinders. The company is expanding its esports presence. Doubling down on mobile gaming. Launching reality TV shows. Setting records for its signature free-to-play franchise.
That’s the sort of environment in which EA stock goes higher, not lower, especially as long as the valuation remains tangible.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an L.A.-based internet venture firm. As of this writing, he did not hold a position in any of the aforementioned securities.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.