Video game stocks have delivered big returns over the last five years, and Activision Blizzard (ATVI +0.00%) and Take-Two Interactive (TTWO 0.59%) have led the charge. Over that time, Activision shares are up 360%, while Take-Two shares have soared 640%. Those gains put the S&P 500's return of 71% to shame.
Activision is known for its Call of Duty franchise, which typically tops the list of best-sellers every year. Take-Two's flagship franchise is Grand Theft Auto; the latest version that released five years ago has sold 100 million copies.
We'll compare both stocks on valuation, risks, growth expectations, and other metrics to determine which is the better buy for investors today.
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Valuation
First, here's how these stocks match up on a range of popular valuation metrics:
| Metric | Activision Blizzard | Take-Two Interactive |
|---|---|---|
| Trailing P/E | 115.1 | 77.8 |
| Forward P/E | 24.9 | 24.4 |
| P/Sales | 7.9 | 8.0 |
| P/Free cash flow | 29.9 | 52.4 |
| PEG ratio | 1.97 | 1.05 |
Data source: Y-Charts and Yahoo Finance!
A booming video game industry has gotten investors excited for all the top gaming stocks, which is why there's not a lot of separation between Activision and Take-Two valuation-wise. The trailing price-to-earnings ratio is not meaningful for Activision because of extra tax charges incurred last year as a result of tax reform. Both stocks are even on the basis of the forward P/E ratio and price-to-sales.
Activision is cheaper when comparing its stock price to free cash flow. But analysts are expecting Take-Two to grow faster than Activision over the next five years based on high sales expectations for Red Dead Redemption 2, which gives Take-Two's share price a lower PEG ratio.
Overall, the valuation comparison is a wash.
Winner: Tie.
Business risk and growth prospects
Take-Two's dependence on Grand Theft Auto V makes its shares a riskier proposition, as opposed to Activision, which has eight franchises that have generated at least $1 billion in lifetime revenue. Currently, Activision has four titles -- World of Warcraft, Call of Duty, Overwatch, and Candy Crush -- that generate two-thirds of its annual revenue.
Take-Two expects its Rockstar studio (the maker of Grand Theft Auto and Red Dead Redemption) to make up 55% of non-GAAP revenue in fiscal 2019 (which ends in March). Grand Theft Auto is one of the best-selling franchises of all time, and Red Dead Redemption 2, which releases later this month, is looking like another winner. Analysts expect Take-Two to grow earnings 27% annually over the next five years largely based on expectations that Red Dead Redemption 2 is going to carry the baton for the aging Grand Theft Auto V.
As for Activision, its growth prospects hinge on its ability to develop successful esports leagues based on top franchises like Overwatch and Call of Duty. Also, the company is branching out to consumer products, cinematic adaptations of games, and mobile advertising. All of these are showing promise for big growth potential, which is why Activision's shares sport a similarly high P/E as Take-Two. Analysts expect Activision to grow earnings 15% per year over the next five years.
Although Take-Two may grow faster than the Call of Duty maker, I believe Activision offers investors the best risk-to-reward because of its greater breadth of titles that drive annual performance. Additionally, as Activision expands its revenue across less capital-intensive categories like brand licensing and advertising, its business risk could become even lower compared to Take-Two over the next decade.
Winner: Activision.
Financial fortitude and profitability
Activision generates over four times the amount of revenue as Take-Two, so naturally Activision has more cash and generates more free cash flow and net income. But since Activision generates some of its revenue from World of Warcraft subscriptions and brand licensing, it's able to generate higher margins than its peer.
Activision generates an operating margin of 20% compared to 9% for Take-Two. Another way to gauge profitability is to compare free cash flow to revenue. On that basis, Activision generates a margin of 26% compared to 15% for Take-Two.
| Metric | Activision Blizzard | Take-Two Interactive |
|---|---|---|
| Cash | $4.9 billion | $1.6 billion |
| Debt | $4.4 billion | $5 million |
| Revenue | $7.3 billion | $1.8 billion |
| Free cash flow | $1.9 billion | $273 million |
| Net income | $505 million | $185 million |
Data source: Y-Charts and SEC filings.
The only negative against Activision is that it has more debt -- a result from the financing management needed to acquire the mobile game maker King Digital Entertainment in 2016. However, management is planning to pay down $1.8 billion of debt this year, so investors shouldn't be concerned about this.
Overall, Activision has the edge here.
Winner: Activision.
Dividends
Activision's superior cash flowing ability has allowed management to pay out a regular dividend since 2010. The current dividend yield is 0.43%, which is low primarily due to rapid share price appreciation in recent years.
Take-Two may be able to pay a dividend someday, especially if it continues to string together big hits like Grand Theft Auto V. But for now, Activision is clearly the best stock for income investors.
Winner: Activision.
The better buy is Activision Blizzard
For investors who are looking to get exposure to the growing interactive entertainment industry -- an industry expected to grow 11% per year to $180 billion by 2021 -- Activision is the safest choice. It offers good growth prospects in addition to regular income through dividends. Plus, its diversification across big franchises and its efforts to create a growing revenue stream spanning merchandise, advertising, movie adaptations, and esports should make the stock a solid investment for decades to come.
