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Nintendo Leaps Ahead

I bet you heard about people willing to pay double or triple the retail price for a Nintendo (OTC BB: NTDOY) Wii over the holidays. I bet many of you -- like me and some other Fools here at headquarters -- have seen the Wii and are intrigued. You've probably even seen and heard that the Wii, and also the Nintendo DS, are pulling in casual players who for various reasons don't want to spend the money or commit the time to today's more advanced game consoles from Sony (NYSE: SNE  ) and Inside Value selection Microsoft (Nasdaq: MSFT  ) .

But if you're a lapsed video game player or just a casual player, you may not have realized that Nintendo's strategy all along has been to get your attention and let Microsoft and Sony slug it out for the hard-core players. The company made this strategy clear in the media and summed it up well in its most recent annual report:

"The video game industry has grown tremendously, but market expansion efforts have stalled because the development of games that are more complex and graphically intense has been the focus of game companies for too long. Declining game software sales in the North American market last year illustrate that this slowing of game sales is now problematic outside the Japanese market as well.

"With these circumstances in mind, Nintendo has implemented a strategy which encourages people around the world to play video games regardless of their age, gender, or cultural background. Our goal is to expand the gaming population."

The strategy is smart because Nintendo avoids competing head-on with the two titans, but risky in that it requires growing the number of players or being attractive enough to lead them to purchase a Nintendo product in addition to another console. The DS was the first serious foray in this strategy, and the Wii is an extension of it. Using its financial performance as the measure of success, I'd say the company is doing quite well.

Apart from a soft year in 2003, Nintendo has always generated plenty of free cash flow, but in 2005 and through the first nine months of 2006, the company's cash flow growth began to accelerate. While we were sleeping Tuesday night, Nintendo released more good news in Japan, increasing its revenue and earnings estimates by 21% and 20%, respectively, with earnings now expected to come in at 120 billion yen ($1 billion) on net margins that should be better than 13%.

All of this, of course, is also good for the game makers, such as Electronic Arts (Nasdaq: ERTS  ) and Konami (NYSE: KNM  ) , and retailers such as GameStop (NYSE: GME  ) . As long as a console gains a large enough following, these companies will do well, and they'll do even better if Nintendo is able to draw more players. But given the royalties earned on software sales and the reported sales of Nintendo's consoles to date, the ultimate winner appears to be Nintendo.

Electronic Arts and GameStop are Motley Fool Stock Advisor selections. To see what other great companies are helping the newsletter crush the market, take a free 30-day trial today. You'll get access to every single buy report as well as community discussion on each one.

At the time of publication, Nathan Parmelee owned shares in Microsoft. He had no financial position in any of the other companies mentioned. The Fool has a disclosure policy.

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