Top companies in the video-game industry have performed extremely well over the last five years, with Activision Blizzard (NASDAQ:ATVI), Electronic Arts (NASDAQ:EA), Take-Two Interactive (NASDAQ:TTWO), and Ubisoft Entertainment (OTC:UBSFF) delivering gains ranging from about 300% to 600%.

We'll look at what drove these gains and how much money you'd have if you invested $1,000 in each stock five years ago.

Woman tossing one hundred dollar bills out of her hand.


Four top gaming brands

First, here's a brief introduction to the four gaming companies we'll discuss:

  • Activision Blizzard has eight games, including Call of Duty, Overwatch, and World of Warcraft, that have generated $1 billion in sales. The company generated $7.3 billion in revenue and $1.9 billion in free cash flow over the trailing-12-month period.
  • Electronic Arts is known for its sports games -- Madden NFL and FIFA. The company generated $4.8 billion in revenue and $1.5 billion in free cash flow over the trailing-12-month period.
  • Take-Two Interactive's Grand Theft Auto V has sold nearly 100 million copies over the last five years and is one of the most popular games in the industry. Over the trailing 12 months, the company generated $1.76 billion in revenue and $273 million in free cash flow.
  • Ubisoft Entertainment is known for its Assassin's Creed, Far Cry, and Rainbow Six Siege franchises. It generated revenue of 1.9 billion euros ($2.2 billion) over the trailing-12-month period. For fiscal 2019 ending in March, the Paris-based game maker expects to generate free cash flow of 300 million euros ($348 million).

Here's how much money you would have in these stocks

The following table shows how much a $1,000 would be worth today if you had purchased each stock five years ago.

Company Price on Aug. 6, 2018 Price on Aug. 6, 2013 % Change Value of $1,000 Invested
Activision $70.57 $17.45 304% $4,040
Electronic Arts $129.03 $26.44 388% $4,880
Take-Two $121.32 $17.96 576% $6,760
Ubisoft $108.50 $15.10 619% $7,190

Data source: Yahoo! Finance. 

Overall, you'd have a total of $22,870 on a $4,000 investment. One of the key trends that have affected the gaming industry over the last five years that is largely responsible for sending share prices soaring has been the shift to digital distribution of games.

The gaming industry doesn't rely on big new hits every year to make money. Instead, companies are relying on the popularity of existing franchises to sell digitally delivered add-on content players purchase while playing a game. Take-Two has been a huge beneficiary of this change with Grand Theft Auto V, which was released in 2013 but still contributes close to half of Take-Two's annual revenue because of the popularity of the Grand Theft Auto Online multiplayer game mode.

Over the last five years, companies have seen revenue derived from digitally delivered games and in-game content grow considerably, which has firmed up margins, allowing these companies to generate more free cash flow, as you can see in this table.

Company % of Revenue from Digital in 2013 % of Revenue from Digital in 2018 2013 Free Cash Flow 2018 Free Cash Flow
Activision 36% 76% $1,190 $1,911
Electronic Arts 44% 73% $218 $1,576
Take-Two 22% 68% ($21) $273
Ubisoft 12% 58% $39 $180

Data sources: The companies. Amounts in millions. Ubisoft free cash flow converted from euros using the conversion rate of 1 euro = 1.16 USD.

Who could have seen this coming?

You didn't have to play games or be a stock market genius to see the opportunity in these stocks in 2013. There were a few clear signals back then suggesting that video-game stocks were a good investment opportunity.

Five years ago, Activision and Take-Two made significant share repurchases, which was a sign that management at each company saw their respective stocks as undervalued. Activision spent $5.8 billion (36% of its market cap) buying back shares in 2013 in order to separate from French media company Vivendi. Take-Two spent $203 million (or 12% of its market cap) to buy back its shares. EA had also spent a total of $820 million repurchasing its shares in fiscal 2013 and fiscal 2012.

These share repurchases were being made at a time when these companies, including Ubisoft, were expressing optimism about the opportunity to grow digital revenue. 

Still, it would have taken a leap of faith to follow these signals and buy shares in EA, Take-Two, and Ubisoft, particularly because these three companies hadn't established consistent profitability prior to 2013. However, Activision's valuation looked cheap on the basis of free cash flow.

On the eve of Activision's $5.8 billion share repurchase announcement in July 2013, the stock's price-to-free cash flow multiple was just 13.3 times. Today, after five years of delivering consistent revenue growth and nearly doubling free cash flow, Activision's stock trades for a more expensive price tag of 27 times its trailing-12-month free cash flow.

The growth story is still unfolding

Although these stocks may not repeat those stellar gains over the next five years, investors are bidding up shares based on high optimism about the future of the industry, and for good reason.

Game companies have emerging growth opportunities in esports, there's also the positive impact new entertainment experiences like game streaming could have on player engagement with popular titles. A few, such as Activision and Ubisoft, are attempting to turn their biggest franchises into movies and consumer product brands.

Valuations have gotten pricier for these stocks, which may not make them the grand-slams they've been in the past few years. But with the industry projected to grow about 11% per year, according to Newzoo, these stocks should deliver gains over the long term.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.