Activision Blizzard (NASDAQ:ATVI) stock is up 50% over the last year and more than 350% over the last five years. This raises the question of whether the stock has risen too far, too fast.
Let's look at Activision's valuation, growth, and long-term opportunities to determine whether the stock is overvalued or still represents a good opportunity for investors.
As of this writing, Activision Blizzard trades for 30 times 2017 expected earnings. One way to see if a stock is overvalued is to compare its valuation with what you can get from other stocks. We'll use the S&P 500 index, which gives us a cross section of some of the best companies in the world. Currently, the index trades for about 19 times forward earnings estimates. This makes Activision's stock appear expensive at first glance. But we need to consider growth expectations.
Analysts expect the S&P 500 index -- which tracks 500 large-cap U.S. stocks -- to grow earnings about 10% per year over the next five years. However, Activision is expected to grow earnings about 18% per year. So, if investors think a 19 times earnings multiple is fair for the average company in the index, it makes sense investors would be willing to pay more for a company that can deliver higher earnings growth.
Let's look at Activision's growth opportunities to understand why analysts expect such strong growth over the next five years.
Long-term growth catalysts
From 2011 through 2016, Activision Blizzard grew earnings per share 134%, or 18.5% annualized, in line with analysts' growth expectations going forward. This growth stemmed from the shift to a digital distribution strategy, which allowed Activision to expand its operating margin from 30% to 35% over the last five years. The company is still in the early stages of growing its digital revenue from in-game delivered content, so it's reasonable to expect margins to move up more over time.
With a diverse portfolio of quality games, Activision has built an audience of more than 400 million monthly active users. This gives the company a massive audience to whom it can sell quality in-game content via micro-transactions in-game. In 2016, in-game revenue more than doubled to $3.6 billion, which was helped by the successful launch of Overwatch, as well as the acquisition of mobile game maker King Digital Entertainment. Upcoming games, such as Call of Duty: World War II and Destiny 2, should keep player engagement up, and perhaps grow monthly active users heading into 2018.
Activision Blizzard has other long-term growth opportunities in mobile games, esports and consumer products. The addition of mobile game maker King Digital Entertainment, which Activision acquired in 2016, gives the company a new profitable revenue channel from the fastest-growing segment in the industry.
One additional perk for Activision shareholders is a current dividend yield of 0.50%, stemming from the game maker's ability to generate consistent annual cash flow beyond what is needed to run the business effectively. The annual dividend increased from $0.165 per share in 2011 to $0.30 per share in 2017. Last year, Activision Blizzard generated $2 billion in free cash flow and paid out $195 million in dividends. Since Activision's capital needs are relatively low, there is plenty of room for management to gradually increase the dividend in the coming years.
Activision Blizzard is still a good investment opportunity
Overall, there is enough current momentum in Activision's business and enough new opportunities opening up that analysts' growth estimates definitely appear doable. Yes, the stock has had a monstrous run, but it was also valued very conservatively five years ago, which didn't factor in the company's ability to expand margins from digital revenue growth. It also didn't factor in the transformative transactions CEO Bobby Kotick would make.
With the ability to create new popular franchises like Overwatch, as well as other opportunities emerging in consumer products and esports, Activision Blizzard remains an attractive stock to own for the long term.