Should You Sell THQ?

The first-quarter results that video game publisher THQ (Nasdaq: THQI  ) reported last week weren't very inspiring at first glance -- unless you thrill to falling sales and a bottom-line loss. THQ's net sales decreased almost 25% to $104.5 million. The company also reported a net loss of $0.14 per diluted share, compared to a net loss of $0.19 per diluted share in the comparable quarter. Adjusting for stock compensation and tax benefits, the net loss becomes $0.09 this year and $0.16 last year.

Management did a good job of keeping the bottom-line picture as pretty as possible, but that top line really was ugly. Investors just don't want to see a deteriorating net-sales picture from a major video game publisher right now. Look at Activision (Nasdaq: ATVI  ) -- its top line expanded by 163%. And even though Electronic Arts (Nasdaq: ERTS  ) saw a revenue decline as well, it was a mere 4% slide.

The market wasn't too happy with THQ last week, with shares closing down more than 4% on Friday. The entire market was having a moody week, but Wall Street's particularly disgruntled that THQ didn't meet its revenue forecasts in the first quarter, and will probably fail similarly in the second.

Despite all this pessimism, I still wouldn't sell THQ. But with shares falling toward the lower end of the company's historical trading range, I must be crazy, right?

Hardly. Going into the holiday season, THQ will benefit hugely from its license to make various games from Viacom's (NYSE: VIA  ) Nickelodeon shows. It should also do well with properties from Disney (NYSE: DIS  ) , including the Pixar hits Cars and Ratatouille, as well as wrestling games based on World Wrestling Entertainment (NYSE: WWE  ) programming. THQ is also working hard to widen its pipeline of original intellectual properties. Previous successes include the Destroy All Humans! franchise and Saint's Row for Microsoft's (Nasdaq: MSFT  ) Xbox 360.

As for valuation, I don't think THQ is too expensive right now. Looking far out into fiscal 2009, Yahoo! Finance states that analysts expect THQ to earn $1.75 per share. That gives the stock a forward P/E of roughly 16, based on Friday's closing price. Analysts believe that the company may grow earnings by 19% per year for the next several years, implying a PEG ratio of less than 1. (I actually think the publisher might do even better than this.).

Rather than selling THQ now, I'd perform serious due diligence on it. The installed user base of the newest video game systems will only expand from this point, and the demand for great software should follow suit. THQ makes some cool games, and I would argue that it's a best-of-breed publisher trading at an acceptable valuation right now, relative to its competitors. While THQ's past quarter was nothing to brag about, the company might not be out of the picture just yet.    

Play some more levels:

Activision, Disney, and Electronic Arts are proud members of the Motley Fool Stock Advisor recommendation list. Sign up for a free 30-day trial of the service with no obligation whatsoever. The Gardner brothers can help you construct a long-term, wealth-building portfolio. Microsoft is a selection of the Motley Fool Inside Value service.

Fool contributor Steven Mallas owns shares of Activision and Disney. As of this writing, he was ranked 8,627 out of more than 60,000 investors in the CAPS system. Don't know what CAPS is? Check it out. The Fool's disclosure policy is better than a cheat code.

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