Investors who have owned shares in any of the leading game makers have fared very well over the past five years. Prominent game companies like Activision Blizzard (NASDAQ:ATVI) and Electronic Arts (NASDAQ:EA) have benefited enormously from the shift to digital distribution of games, which has fueled rapid growth in earnings and sent share prices soaring.

With esports turning gaming into a mainstream entertainment activity for millennials, the industry still offers much upside over the long term. For investors who are looking for the single-best gaming stock to get in on the trend, Tencent Holdings (NASDAQOTH:TCEHY) might be the ticket. 

Man playing a computer game with a stadium audience in the background.

IMAGE SOURCE: GETTY IMAGES.

Tencent operates in the biggest gaming market

Online games counts as one of Tencent's largest revenue drivers, generating about 40% of total company revenue. In 2017, the gaming segment booked $14.9 billion in revenue, making Tencent the No. 1 video game company in the world.

Tencent's gaming revenue has more than doubled since 2014. It's not the fastest-growing segment for the Chinese tech giant, nonetheless, online games revenue has expanded at an average annual rate of 30% per year:

Segment 2017 2016 2015 2014
Online gaming $14.9 $10.2 $8.7 $7.3
Total revenue $36.4 $21.9 $15.8 $12.9

Data source: Tencent Holdings. Amounts in billions.

Underpinning this success is China's status as the largest and fastest-growing global game market, one that's estimated to reach $38 billion in size in 2018. China boasts both the largest number of players and the largest esports audience in the world. Tencent is in a prime position to benefit from the esports trend with its ownership of League of Legends creator Riot Games: The company's annual League of Legends championship has drawn audiences rivaling the NBA Finals in recent years. Tencent also publishes several other popular multiplayer titles from its vast portfolio of licensed and wholly-owned game studios.

Mobile gaming is particularly hot and is expected to make up 70% of China's gaming market by 2021, according to gaming market data research provider Newzoo. Tencent's mobile games, including Honor of Kings (Arena of Valor), PUBG: Mobile, and QQ Racing, rank among the top-grossing games in China.

A powerful gaming arsenal

One thing to grasp about Tencent is that it's not just No. 1 in games, but it's the leader in China across social media, mobile payments, and other digital entertainment. This gives Tencent an extremely powerful marketing and distribution capability for its mobile games. It also provides the tech giant lucrative revenue streams in several fast-growing online platforms. In 2017, the company generated $14.4 billion in free cash flow.

What does Tencent do with its cash? Well, it doesn't have the word "holdings" in its official corporate title for nothing -- it buys stakes in other game companies.

Tencent has invested in some of the best game makers in the world. It owns a 5% stake in both Activision Blizzard and Ubisoft Entertainment, and holds a 21% interest in mobile game maker Glu Mobile. It has partnered with the leading U.S.-based companies, such as Activision, Electronic Arts, and Take-Two Interactive to distribute their best-selling franchises in China.

Tencent owns the PC publishing rights and mobile development rights in China for Bluehole's PlayerUnknown's Battlegrounds (PUBG), which, along with League of Legends and its minority stake in privately-held Fortnite creator Epic Games, puts Tencent at the epicenter of the multiplayer/esports trend sweeping across the gaming industry.

Tencent leverages its social platforms to sell games

One reason Tencent invests in these numerous game companies is to beef up its online games store, WeGame, where gamers buy and download titles.

Consider that for a moment. Tencent not only has an economic interest in some of the most-played games in the world (League of Legends and Fortnite both have player bases of at least 100 million), but it also operates as a major game distributor in the largest global game market.

And because of Tencent's powerful position as a social media giant, with 694 million people using its QQ instant messaging platform, and 550 million using its Qzone social network, nearly every top game maker must partner with the Chinese tech giant to successfully market to the more than 600 million people who play games in the Middle Kingdom.

Tencent offers broad exposure to the gaming industry

While the company does incur some game development costs through its wholly-owned studios, including Riot Games and other developers, for the most part, Tencent benefits from the growth of hit games (Fortnite and PUBG) without bearing the financial burden of game development expense, which can run to hundreds of millions of dollars over several years.

If you're looking for one stock to provide broad exposure to a booming gaming industry, Tencent certainly has a lot to offer. It's dominant in the fastest-growing game market, and it has plenty of diversification across numerous games. This puts Tencent in a very advantageous place and indicates that it will continue to rake in big profits, grow its gaming revenue, and remain the world's largest video game company going forward.


 

John Ballard owns shares of Activision Blizzard. The Motley Fool owns shares of and recommends Activision Blizzard and Tencent Holdings. The Motley Fool recommends Electronic Arts. The Motley Fool has a disclosure policy.