Top Stocks in Gaming

It's said the odds always favor the house, which is why investing in casino stocks may not be a bad bet. And where you were once limited to gaming companies that had resorts in either Las Vegas or Atlantic City, changes to the industry over the years have opened the world to investors.

From Macau to Australia, Singapore to the soon-to-open Japanese casino market, gaming companies have extended their reach to far corners of the globe. But don't neglect the smaller domestic markets either. Regional casino players have flourished as states have legalized gambling making gaming companies a rich universe of stocks to choose from.

So let's look at some of the segments within the casino industry and explore a few things investors should look for when picking an investment in this industry.

Image source: Getty Images.

Sorting the dance card

For investors, there are two distinct categories of gaming companies: the global operators with their world-class resorts and the regional gaming companies. Each has their benefits and drawbacks as investments, which we'll get into below. Here are the leading gaming companies that trade on the NYSE and the Nasdaq.

Data source: YCharts and company SEC filings. Table by author.

It's clear there are a lot more opportunities in regional gaming centers than of the global sort, but those building world-class resorts in far-flung destinations tend to be the biggest, most financially secure players -- the troubles of both Caesars Entertainment and Wynn Resorts notwithstanding.

Playing close to home

For example, the regional gaming market has been undergoing significant consolidation. Last year, Eldorado Resorts bought Isle of Capri Casinos and the most recent deal between Penn National and Pinnacle points to the fact that smaller markets are sometimes a tough go. Moreover, it has pitted states against one another, such as the proliferation of casinos in Pennsylvania and Maryland siphoning off gamblers from Atlantic City. New Jersey ended up killing its own in-state casino expansion proposals over fear of what it would do to the casinos that remained at the seaside resort.

While Penn National and Boyd Gaming have emerged as the two biggest players in the regional gaming market, Churchill Downs is something of a unique, niche situation. While a number of regional operators also own racetracks, the owner of the iconic Kentucky Derby derives most of its revenues from racing, primarily from its namesake track that holds the Run for the Roses. But it also operates casinos in eight states, and their combined revenue surpasses those generated by horse racing.

Standing on the world stage

Las Vegas was obviously the launching pad for many of the casinos that went on to become world-renown resort operators, but it was the opening of the Chinese market to legal casino gambling in Macau that catapulted them to the forefront. Today, the biggest global players derive a substantial portion of their revenue, if not almost all of it, from their operations in Macau, the only place in China it's legal to gamble.

That hasn't been without its risks as well. A crackdown on corruption to stop wealthy Chinese people from laundering money through the casinos led the Macau market into a two-year tailspin. While it has since pulled out of the deep dive, the peninsula has yet to recover the heights it previously attained.

It also allowed other markets in Asia to establish a foothold and now Australia, Singapore, and elsewhere are in the midst of a growth cycle. Japan is looking to capitalize on the opportunity as well, and a bidding war between the largest resort operators to win one of the very limited licenses that will be issued initially may prove just how sharp the elbows are in the process.

Analysts estimate Japan could become the world's biggest casino market with a value approaching $40 billion -- well in excess of what Macau achieved even at its height.

Unique to each market

There are things that every company must do to be successful, such as possess a strong balance sheet, generate a return on its investment, and allocate capital in a prudent manner, but there are also certain industry-specific things that resort operators need to do well to be a viable investment.

Adjusted property earnings before interest, taxes, depreciation, and amortization (EBITDA) is a key, closely watched metric for gauging profit growth at resorts, and comparing it to their debt load will give a sense of just how healthy the business is. Those with hotel operations will also mandate that investors track occupancy rates, average daily rates charged for rooms (ADR), and revenue per available room (RevPAR) to understand the contribution these facilities make to profits.

Image source: Getty Images.

In certain markets, there will be other things to watch out for. In Asia, for instance, VIP gaming is a critical lever for growth and it has been carrying the resort operators in Macau as the industry bounces back from its recession. Watching the VIP baccarat numbers will provide direction to which way the market may turn. Yet with the government calling for resorts to implement avenues of entertainment geared toward a mass market audience, VIP gaming's importance will eventually diminish though never really go away.

Still a good bet

There are ebbs and flows to all industries -- casino and resort operators included. The Las Vegas market seems to rise and fall regularly, but those plying the trade in northern Vegas have lately seen a rebound. As we've also noted, Macau is coming out of a steep decline, and Atlantic City always seems to be hanging by a thread.

The widely dispersed regional markets have their own puts and takes, such as Pennsylvania opening a new mini-casino market that gaming companies like Boyd Gaming have objected to but are participating in nonetheless as a means of protecting their established facilities.

That just means that while gaming companies might be a good bet for investors, they're not a sure bet and due diligence is still required.