Generally speaking the aim of active stock picking is to find companies that provide returns that are superior to the market average. And while active stock picking involves risks (and requires diversification) it can also provide excess returns. For example, the Electronic Arts Inc. (NASDAQ:EA) share price is up 90% in the last 5 years, clearly besting the market return of around 35% (ignoring dividends). On the other hand, the more recent gains haven't been so impressive, with shareholders gaining just 28%.
In his essay The Superinvestors of Graham-and-Doddsville Warren Buffett described how share prices do not always rationally reflect the value of a business. One way to examine how market sentiment has changed over time is to look at the interaction between a company's share price and its earnings per share (EPS).
Over half a decade, Electronic Arts managed to grow its earnings per share at 30% a year. This EPS growth is higher than the 14% average annual increase in the share price. Therefore, it seems the market has become relatively pessimistic about the company. This cautious sentiment is reflected in its (fairly low) P/E ratio of 11.55.
The image below shows how EPS has tracked over time (if you click on the image you can see greater detail).
It is of course excellent to see how Electronic Arts has grown profits over the years, but the future is more important for shareholders. Take a more thorough look at Electronic Arts's financial health with this free report on its balance sheet.
A Different Perspective
We're pleased to report that Electronic Arts shareholders have received a total shareholder return of 28% over one year. That's better than the annualised return of 14% over half a decade, implying that the company is doing better recently. Given the share price momentum remains strong, it might be worth taking a closer look at the stock, lest you miss an opportunity. I find it very interesting to look at share price over the long term as a proxy for business performance. But to truly gain insight, we need to consider other information, too. Like risks, for instance. Every company has them, and we've spotted 3 warning signs for Electronic Arts (of which 2 can't be ignored!) you should know about.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of companies we expect will grow earnings.
Please note, the market returns quoted in this article reflect the market weighted average returns of stocks that currently trade on US exchanges.
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This article by Simply Wall St is general in nature. 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. Thank you for reading.