Video Games Losing Power?

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Is the video game market catching a cold? Yesterday, Motley Fool Stock Advisor recommendation Electronic Arts (Nasdaq: ERTS) announced lower revenue and earnings guidance for 2005 because of a falloff in catalog sales. Then today, video game retailer GameStop (NYSE: GME) is reporting that fourth-quarter same-store sales increased an anemic 0.2% over the year-ago quarter. That's hardly encouraging, either. So what's up? Well, the stock is, at least -- GameStop shot up 12% as of this afternoon, partly on news that total quarterly revenue increased 13%.

The news is confusing because game system suppliers cut the prices of their consoles to $150 and sales are booming -- so much so that there are shortages of the consoles. With Microsoft (Nasdaq: MSFT) launching the Xbox 2 later this year and Sony (NYSE: SNE) ready with a PlayStation 3 for 2006, there is no incentive to build any capacity for the older models. But shouldn't robust console sales be zapping same-store sales higher?

Well, if you make the games -- at least the right ones -- sales can be very robust. Take-Two Interactive Software (Nasdaq: TTWO), home to the hot Grand Theft Auto franchise, reported that net income increased 74% for its latest quarter year over year. Net income at Stock Advisor recommendation Activision (Nasdaq: ATVI) was up 26% during its latest quarter. Sales are going so well at THQ (Nasdaq: THQI) that the company just raised earnings guidance.

So, from a game perspective, Electronic Arts looks to be having its own problems -- for now. But with new consoles coming that allow for more advanced game features, expect the industry giant to dust itself off and come out shooting at the competition.

On the other hand, GameStop, which competes with many retailers, including Wal-Mart and Best Buy, is looking to earn up to $1.40 a share this fiscal year (up from $1.17 last year), giving the stock a forward P/E ratio of 16.

But that good news is built on a same-store-sales expectation that runs from flat to as much as 5%. That's hardly encouraging, and it makes you wonder what will happen to sales in bad times.

Those looking to GameStop for an exposure to video gaming should consider that the sweet spot in the industry is in the game software. Players like Activision and Take-Two sell for 18 times forward earnings -- a slight premium to GameStop, but without the risk of having a Wal-Mart or Best Buy lurking the background.

Fool contributor W.D. Crotty does not own shares in any of the companies mentioned. Click here to see The Motley Fool's disclosure policy.