If The Motley
Fool were bought out by some megamedia corporation that promptly fired the two
founding brothers, I would rapidly deliver my resume to just one company:
Electronic Arts (Nasdaq: ERTS).
Electronic Arts is America’s leading company in entertainment software. During
the fiscal year that ended on March 31, 2005, the company racked up sales of
$3.1 billion and profits of $504 million, leading to net profit margins of 16%
(or 16 pennies of profit on every dollar of sales). Nobody produces more video
games, and more good video games, than Electronic Arts.
As I hypothetically applied for work (entry-level game tester sounds just
fine!), I would be choosing as my employer a company that has risen nearly 200%
vs. an S&P 500 that has lost value over the past five years — and has been a
growth-stock investor’s dream since it came public in 1989 years ago, rising
almost 11,000% as of mid-2005. Wow.
I think Electronic Arts has lots more room to grow, and I believe the company
will continue to beat the market over the next three years. The company has
already rewarded longtime subscribers of The Motley Fool Stock Advisor, as my
original May 2002 recommendation is up more than 70% as of this writing, with
the market up only 6% over the same period. But I ’m one of those investors who
likes to add to my winners over time. I’m emboldened by the stock’s performance,
not leery of it. I think anyone who’s investing for 20 years or more should have
to produce good reasons that this stock doesn’t merit inclusion in his or her
portfolio.
Electronic Arts owns a mix of old standby marquee properties alongside a nice
crop of dynamic, newer properties. A good example of the former is its Madden
football game franchise. In 2003, ERTS sold 4 million copies of this game
starting at $50 a pop. In 2004, the company sold more than 6 million copies of
the updated version, bringing total franchise sales to more than 43 million. Do
the math with me and you’ll find that’s like a recurring Hollywood blockbuster
movie every year.
Indeed, in contrast to Hollywood, hits in the video game field can create
long-term streams of increasing profits. Hollywood doesn’t have anything
similar; there are no movies franchises that produce hits every year for 15
years with growing profits. But Electronic Arts does that quite ably.
I am personally enamored with the Madden series — as are so many NFL players,
who play the game — play themselves — in their hotel rooms! And EA Sports games
dominate sales in most major sports. But the company’s The Sims and its various
software add-ons are similar mega-sellers; The Sims is the No.1 personal
computer game of all time.
In fact — and this is a principal point — Electronic Arts is growing so big and
dominant in interactive entertainment that it easily wins Hollywood contracts to
create companion video games for many of the big blockbuster movie titles. This
is a trend that should continue for a long time, putting Electronic Arts with
its peerless resources and reputation in a really good place.
I believe that Electronic Arts can grow its earnings and casbh flow at 15% per
year for the next 10 years. For that reason, I don’t mind paying around 40 times
earnings for this stock.
Now, the multiple makes the stock look like it won’t beat an index fund over the
next 10 years. So why buy Electronic Arts? First, because I think it could well
beat my expectations. Second, for an investment I’m planning to keep for a few
decades, I am happy to “overpay” in the short term to own the long-term
sustained growth I think I’ll get from Electronic Arts. And the company is
awfully tough to compete with.
I love stocks of businesses I understand that possess defensible double-digit
net profit margins. Long story short: I think these shares will beat the market
over the next few years.
