- Electronic Arts is the top sports video game publisher in the world.
- Nintendo has dominated the gaming industry for decades.
- Take-Two Interactive is rapidly growing its live services business.
In 2021, it was estimated that people spent $178 billion on video games worldwide, making it one of the largest consumer categories. That number is expected to grow at a rapid pace to $269 billion in annual spending by 2025. This means that, over the next three to four years, there will be approximately $91 billion in new annual spending on video games that companies can go after. This huge secular tailwind makes the gaming industry an attractive hunting ground for finding potential new investments.
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1. Electronic Arts
Electronic Arts is the premier publisher of sports video games in the world. It is best known for its FIFA Soccer and Madden NFL franchises, which are the biggest earnings drivers among its sports titles. On top of the sports franchises, EA has many other games, the most important being Apex Legends, the Sims, Battlefield, and some Star Wars games.
In 2021, EA made multiple acquisitions, mainly to bolster its mobile and racing game strategy. It acquired Codemasters, the top racing video game developer, for $1.2 billion. The purchase includes the rights to the Formula One video game franchise, which is one of the fastest-growing sports in the world. The company also bought Glu Mobile for $2.4 billion early in 2021, which brought in a bunch of existing mobile games and a large team of mobile game developers. EA management hopes these two acquisitions will help grow its mobile gaming bookings (the revenue equivalent for video games). Last quarter, the company showed good progress in this strategy, with mobile bookings growing 62% year over year to $279 million.
For fiscal year 2022, which ends in March, EA expects to generate $7.6 billion in net bookings and $1.95 billion in operating cash flow. With a market cap of $37.4 billion, EA trades at a forward price-to-operating cash-flow (P/OCF) ratio of 19. If you believe the company can continue to grow bookings and cash flow at a steady rate over the next decade, now could be an optimal time to take a position in this long-term compounder.
This second stock is probably the most recognizable video game company in the world: Nintendo. The company has stayed close to or at the top of the video game industry for decades, building huge franchises like Mario, Zelda, and Animal Crossing, just to name a few. It also owns a large chunk of the Pokemon Company, the top entertainment franchise in the world, giving it exclusive rights to publishing the Pokemon video games.
Along with game development, Nintendo sells its own hardware devices. Its most recent iteration is the Nintendo Switch, which has sold almost 93 million units since its launch in 2017. There are two big metrics for Nintendo investors to watch, both interrelated. First, the core of the business starts with hardware unit sales. For the full fiscal year ending in March, management expects to ship 24 million Switch units, which is held back some due to semiconductor supply constraints. Over the next few years and beyond, investors should expect Nintendo to continue selling a large number of Switch (or whatever the next console will be called) devices to help keep its business humming.
Hardware sales lead to software (i.e., game) sales, the other important metric for investors to follow. For the full fiscal year, Nintendo is expecting to deliver 200 million software units. This leads to operating profit guidance of $4.5 billion for the full fiscal year. With a market cap of only $42 billion when you cancel out the company’s huge cash pile, this gives the stock a forward price-to-operating-profit ratio of only 9.3. This is dirt cheap for a company that has dominated the gaming industry for so long, which is why it is one of the best gaming stocks to buy this month.
3. Take-Two Interactive
To round out this gaming basket, we have a stock that is not as cheap as Nintendo or EA but has put up impressive growth numbers over the past decade. This stock is Take-Two Interactive, the publisher of Grand Theft Auto, Red Dead Redemption, and NBA 2K. It has other franchises that it publishes games for, but these three are the most important from an investing perspective.
Over the last decade, Take-Two has driven earnings and bookings growth through its live services, which bring in more recurring revenue from customers. The most important of these is GTA Online, the virtual world/gaming playground attached to Grand Theft Auto V. Even though GTA V was released all the way back in 2013, Take-Two is still generating plenty of bookings and cash flow from GTA Online with the 40-plus updates it has released since launch. It has also seen nice contributions from NBA 2K live services and Red Dead Redemption Online.
From a financial perspective, Take-Two’s recurring customer spending grew at a 37% compound annual growth rate (CAGR) from fiscal year 2017 to fiscal year 2021. In absolute terms, recurring bookings grew from $665 million to $2.3 billion over that timespan. This has driven overall net bookings to grow at a 17% CAGR, hitting $3.5 billion in fiscal year 2021.
In fiscal year 2021, Take-Two generated $912 million in operating cash flow, which is expected to drop to $380 million in fiscal year 2022 (which ends in March) as Take-Two reinvests for more growth and future game releases. With a market cap of $18.2 billion, that gives Take-Two stock a P/OCF ratio of 47.9. This looks expensive, but investors should expect cash flow to inflect back up closer to or above $1 billion a year over the next few years, as Take-Two gets out of this current development cycle and starts publishing more games, one of which could be GTA VI.
If you have confidence in Take-Two’s development execution and think it can continue growing its live services bookings at a high rate, then an $18.2 billion market cap is much too cheap for this long-term compounder.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
Brett Schafer owns Electronic Arts and Nintendo. The Motley Fool owns and recommends Take-Two Interactive. The Motley Fool recommends Electronic Arts and Nintendo and recommends the following options: long January 2023 $115 calls on Take-Two Interactive. The Motley Fool has a disclosure policy.