Investors should always be aware of the risks facing the companies they're buying, not just where their upsides may come from. And in Las Vegas, risks always seem to pop up just when investors think there aren't any.
Eight years after the bottom of the financial crisis' stock market plunge -- which included a severe drubbing for MGM Resorts (NYSE:MGM), Las Vegas Sands (NYSE:LVS), and Wynn Resorts (NASDAQ:WYNN)-- it's worth considering where their risks lie in the future.
A falling tide sinks all casinos
No factor drives earnings in Las Vegas more than the economy overall. You can see in the chart below that gaming revenue on the Las Vegas Strip slowed in the early 2000s when there was a recession, surged until 2007, and then crashed with the financial crisis and the resulting recession.
The recovery in gaming revenue was sharp until 2013 when the industry reached a steady state -- somewhat analogous to the tepid economic recovery overall.
If economic growth continues or picks up steam, it would be great for gaming stocks, especially given the stagnation of supply on The Strip. But after eight years without a recession, it's only a matter of time (whether that's months or years) before the economy slows down or contracts again.
Ill timed bets can come back to bite you
The deeper risk in downturns is that gaming companies will be overextended financially when they arrive. Notably, this happened to Las Vegas Sands in 2008 and early 2009, requiring a bailout from founder Sheldon Adelson. But it was Adelson's massive build-out of resorts in Macau and Singapore that put the company at risk in the first place.
Today, Las Vegas Sands is arguably in the best position financially of any gaming company, thanks to its incredible performance in Asia over the past eight years. But Wynn Resorts has been adding debt to build its recently opened Wynn Palace Cotai in Macau, and Wynn Boston Harbor, slated to open in 2019. Could these be ill-timed bets if the economy takes a turn for the worse?
I'm not saying that Wynn's expansion efforts won't pay off, but if a recession hits at the wrong time, the leverage could come back to bite it in the balance sheet.
Learn the lessons of the past
These risk factors I'm talking about aren't just a hypothetical either. The gaming industry has a long history of boom-and-bust cycles, and the most notable bust was in the last recession. You can see below that Wynn Resorts was the only big Vegas gaming stock to have a positive return over the past decade, through the recession, while MGM and Las Vegas Sands are still in the red for investors.
As investors, it's worth learning from the past, and in the gaming industry, it's always important to keep an eye on both the macroeconomic situation and the leverage companies are holding on their balance sheets when the economy goes south. Those are the biggest risks to investing in gaming stocks.