Trading at roughly 42 times trailing earnings and 30 times this year's expected profits, Activision Blizzard (ATVI +0.00%) doesn't fit the typical value-stock profile. Those earnings multiples mean that the video game publisher is more often grouped in the "growth stock" category. However, these terms are somewhat imprecise -- and sticking too narrowly to the investing approaches they imply can lead to missed opportunities.
In many cases, whether a stock is a smart growth play ultimately comes down to how much the business is growing and what price you've paid for that growth. Activision Blizzard is certainly growing quickly, but does its stock still present big upside opportunity after gaining more than 450% over the last five years? Let's take a look.
Image source: Activision Blizzard.
A look at the fundamentals
As Motley Fool writer John Ballard recently pointed out, the average analyst estimate expects the companies in the S&P 500 index to grow earnings at an average of annual rate of 10% over the next five years and for Actvision Blizzard to increase earnings 18% annually over the same stretch. With the S&P 500 trading at roughly 20 times the average of its components expected earnings and Activision trading at 30 times forward earnings, investors are paying substantially less for the video game publisher's expected growth over the next five years.
While the company looks to present solid value by some metrics, it's important to point out that its trailing P/E value is at its highest point in five years. On the other hand, the company has never looked stronger, thanks to an improving franchise portfolio and new growth opportunities in areas such as esports and consumer products.
Activision's forward price-to-earnings growth ratio sits at roughly 0.6. With a PEG ratio of less than 1 often used as a marker for a stock being cheap, this metric adds to the argument that the stock is still a value buy at current prices. The company has a solid balance sheet as well, carrying roughly $3.3 billion in cash and short-term equivalents against roughly $4.4 billion in debt. That's pretty good, considering the company used $3.4 billion in cash and $2.3 billion in new loans to fund its $5.9 billion acquisition of King Digital in 2016.
The company also pays a dividend, and while its roughly 0.5% yield isn't much, the publisher has raised its payout annually for seven years and doubled its disbursement over the stretch. With the cost of distributing its current dividend representing just 15% of trailing earnings, the company has plenty of room for payout growth.
Important intangibles
Just looking at raw metrics and growth projections might not paint an accurate picture of whether a company in the fast-changing video game industry is a worthwhile value play. This is even more true for a company like Activision, which has designs on branching into the film industry, being a leader in esports, and making emerging technologies like mixed reality a much bigger part of its overall business. Growth for digitally purchased software and in-game items will help the company continue to improve its margins and is at least somewhat predictable, but other growth avenues are earlier along and more difficult to model.
Even in an established business like mobile, Activision's opportunities in mobile could be underappreciated. Acquiring King Digital brought Candy Crush Saga and other hit mobile titles into the corporate fold, but King has yet to transition big Activision Blizzard properties to smartphones and tablets. The unit is currently working on creating a mobile version of Call of Duty, and there are a range of other franchises that are ripe for transition to mobile.
King is also in the early phases of rolling out in-game advertising. The unit's games currently generate nearly all of their sales from users who purchase in-game items, but these users represent a relatively small slice of the mobile publisher's roughly 300 million strong player base. Between adapting big franchises to mobile and finding new ways to monetize King's player base, I think the company is still just scratching the surface in mobile.
Comparing the company to its chief industry rival, Activision looks comparably priced to Electronic Arts based on metrics like P/E and PEG but has bigger growth opportunities in categories such as mobile, esports, merchandising, and mixed reality thanks to its stronger franchise portfolio.
Activision Blizzard's moat
Along with Activision Blizzard's nearly unrivaled stable of franchise properties, the video game industry's high barrier gives the company a formidable competitive moat. While developing independent games is easier than ever before, the cost and expertise required to release graphically advanced games that have complex gameplay systems and features remains prohibitive to new entrants.
Disney, with all of its valuable characters and franchises, tried to make a go at the industry but ultimately shuttered its game unit last year. Amazon.com, with its deep pockets, cloud infrastructure, and the advantages that come with owning the Twitch streaming platform, opened up a development wing in 2014, but rumors suggest that its flagship title is being canceled or put on hold. Game development is difficult, and the overall trend over the past decade is that more large publishers have fizzled out or been absorbed by stronger competitors than have successfully entered the space.
Activision is worth holding for the long haul
By some metrics, it might not look as if Activision Blizzard is undervalued at today's prices. Even then, I think it would fall into the "great company at a fair price" mold. That's hardly a knock on the stock.
On the other hand, looking at the tailwinds that are boosting the video game industry and intangibles such as brand strength and potential to capitalize on emerging opportunities, the stock appears to present an attractive value proposition. The publisher has had a tremendous run, but based on the strength of its business and a range of catalysts for the global video games market, I expect that hindsight will recast the stock as being quite cheap at current prices.
