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Three Gaming Stocks

Video games have a little bit of an image problem. Partly it’s the name--having “game” right in there makes it hard for some people to take them seriously. Video games also suffer from being seen as a “niche” product and not something with mainstream appeal. But video games have grown into...

Video games have a little bit of an image problem. Partly it’s the name—having “game” right in there makes it hard for some people to take them seriously. Video games also suffer from being seen as a “niche” product and not something with mainstream appeal. But video games have grown into a billion-dollar industry nonetheless; they now rival DVDs for the entertainment we spend the most on (having already surpassed movie ticket sales).

And the growth continues. The global market for console games (those played on the Xbox, PlayStation, Wii and other dedicated gaming devices) has been growing at a compound annual growth rate of 6.9% and is expected to reach $34.7 billion this year. The market for online games (which includes massively multiplayer online role-playing games (MMORPGs) like World of Warcraft and Facebook games like Farmville) is growing even faster, at 16.9% per year, and is expected to reach $14.4 billion this year. But the fastest-growing segment is mobile gaming, which has grown 19% per year recently and is expected to become a $13.5 billion market this year.

And it’s not just teenagers spending that money. According to a 2011 study, the average age of today’s gamer is 37 years old! Eighty-two percent of gamers are 18 years of age or older, and 42% percent are women. In part, that’s because video games have simply been around for a while now—the average gamer has been playing for 12 years. People who played video games as kids are adults now, and they’re still playing. As Tom Bissell wrote in his book, Extra Lives: Why Video Games Matter, “By 2020, there is a very good chance that the president will be someone who played Super Mario Bros. on the NES.”

In short, the video game industry (also called the interactive entertainment industry) is a huge, fast-growing market, with profits to be shared.

Lately, some of the investing experts who contribute to the Digests have realized this too, and there have been three video game companies featured in the Investment Digest in recent months.

The first, back in October, was Activision Blizzard, Inc. (ATVI), one of the giants of the industry. Activision Blizzard makes World of Warcraft, the world’s most popular MMORPG, with 10.3 million subscribers as of September 2011. The company also owns the Guitar Hero, Call of Duty and StarCraft titles, among others. The latest game in the Call of Duty series, released in November, grossed a record-breaking $400 million on its first day of sales alone.

However, Activision Blizzard’s stock has been lying fallow ever since it took a tumble following the company’s third-quarter earnings release on November 8. The stock had gained 20% in the three months leading up to the earnings release, and though the earnings beat expectations, they couldn’t sustain the advance. (Analysts pointed to a 7% decline in World of Warcraft subscribers as the culprit.) ATVI has spent the month-and-a-half since the decline ended consolidating between 12 and 13, possibly building a base for a second upmove. The base could—and possibly should—stretch out longer, but I wouldn’t be surprised to see investors come back to this name.

The second video game stock showed up in the Digest on November 16. Take-Two Interactive Software, Inc. (TTWO) was recommended by Gregory Spear, editor of The Spear Report. He wrote:

“Generally speaking, the boom-bust cycles in the technology sector have been smoothed out. In most niches within the tech ‘space,’ growth is steady, but not spectacular. There is one exception, however: video games. In the video game market, product cycles are short, around two to three years. Profits plunge during the last half of the period and soar when the new cycle kicks in. Take-Two Interactive, which owns the top-selling Grand Theft Auto franchise, among others, is a case in point. The company is a leading developer of addictive, interactive entertainment designed for console systems like PlayStation and Xbox, as well as PCs, handheld gaming systems, smartphones and tablets. The games are delivered through retail stores, digital download and online streaming platforms. Take-Two reported a huge net loss in the latest quarter ($47 million). Revenue fell 56% from a year earlier to $107 million. In the spring, however, when Grand Theft Auto 5 is released, analysts expect annual EPS to jump more than 1,000% to $2.38/ share. According to comments from the CEO, Take-Two has the strongest development pipeline in the company’s history. This announcement came along with news of a $200 million convertible debt offering that took shares down 7% on November 10. Considering that TTWO had $269 million in cash at the end of the quarter, the cash infusion will probably be used to fund an acquisition. ... As evidenced by the 13% short interest, many investors are skeptical of TTWO. That said, shares are trading above the 200-day moving average, a standard bull/bear line in the sand. Technically, the $15 stock has potential upside to the $22 area. A surprisingly attractive acquisition would provide the catalyst.”

Since then, shares of TTWO have held their ground right around that 200-day moving average line and the situation remains pretty much as Spear described it. This is another one to keep an eye on.

The last of today’s three video game stocks was recommended in the January 4 Investment Digest. Changyou.com Ltd. (CYOU) is a Chinese game company spun off from Sohu.com (SOHU) in 2009. The company has two popular MMORPG titles as well as several more casual web-based games. The hook here is Changyou’s consistent double-digit earnings growth. The stock also has low institutional ownership, at 22%, so any jump in popularity could be huge.

Unfortunately, CYOU is in a pronounced downstrend. The stock drew out a well-defined sequence of higher highs and lower lows in early 2011, but then it totally collapsed in August, and hasn’t looked back. Now, some analysts are calling it a bargain. But as with the other two, I’d wait until an uptrend actually begins.

It’s possible there will be more false starts and fake outs from these stocks, as investors’ belief in the interactive entertainment industry seems to be grudgingly given, and easily taken away. But these companies’ growth and profits are real, and I think Wall Street is (slowly) waking up to that fact.

Wishing you success in your investing and beyond,

Chloe Lutts

Editor of Investment of the Week

Chloe Lutts Jensen is the third generation of the Lutts family to join the family business. Prior to joining Cabot, Chloe worked as a financial reporter covering fixed income markets at Debtwire, a division of the Financial Times, and at Institutional Investor. At Cabot, she is a contributor to Cabot Wealth Daily.