Electronic Arts Inc. (EA): Let’s Play A Game

Let’s play a game.

I’m going to tell you a story, and then it’s your job to identify what’s wrong with it.

On May 7, this past Tuesday, video-game maker Electronic Arts Inc. (NASDAQ:EA) reported earnings for its fiscal fourth quarter and full year ended March 31. Its revenue for the quarter was $1.209 billion, equating to a 11.6% decline compared with the same quarter last year. And for the year, its sales came in at $3.797 billion, or 8.4% less on a year-over-year basis. On the heels of this news, shares of the company ended the week higher by 27.2%, making it the top-performing stock on the S&P 500 .

According to Electronic Arts Inc. (NASDAQ:EA) Executive Chairman Larry Probst: “As we enter a new fiscal year, EA is well positioned for dynamic growth on next generation consoles, PCs, and mobile platforms. With world-class games, a rapidly growing digital business, and top-notch creative talent, we are excited about Electronic Arts Inc. (NASDAQ:EA)’s strategy for FY 2014 and beyond.”

So, to get back to our game, what (if anything) is wrong with this?

If you think there’s a disparity between its actual performance and the reaction of the market, then you’re not alone. How is it possible that a company that manufactures products to sell could be rewarded in the market for recording a double-digit decline in year-over-year quarterly revenue? That’s not a rhetorical question; I’m actually curious.

To be fair, Electronic Arts Inc. (NASDAQ:EA) did report growth in its bottom line. For the 12-month time period, it earned $0.31 in diluted earnings per share compared with $0.23 the preceding year. However, and this is an important point, all of the growth came in the previous three quarters, as its fourth-quarter diluted EPS was actually less by 13.2% on a year-over-year basis.

The catalyst for the move in its stock, in turn, clearly had nothing to do with its performance. The dramatic uptick was predicated rather on future expectations (that’s a nice way of saying “hopes and dreams”).

In the first case, the company raised its guidance for fiscal year 2014. It now expects to earn $1.20 in non-GAAP diluted EPS. That compares with an average analyst estimate of $1.08 per diluted share. And in the second case, the company announced a partnership with The Walt Disney Company (NYSE:DIS), under which Electronic Arts Inc. (NASDAQ:EA) now has the rights to create games based on the Star Wars franchise, though — and this, too, is a critical point — the financial terms of the deal have not been disclosed (use your imagination about who had the negotiating leverage here).