Why Weren't Investors Happy With Activision Blizzard's and Take-Two Interactive's Outperformance?

Video game standouts Activision Blizzard (ATVI) and Take-Two Interactive (TTWO -1.76%) beat expectations for their third-quarter earnings, but Wall Street dinged them anyway, sending shares of both down by double-digit percentages.

In this segment from Motley Fool Money, host Chris Hill and senior analysts Jeff Fischer, David Kretzmann, and Jason Moser discuss what might have been behind investors' pessimism. Activision's recent launches were successful, but its guidance was a little light. And while Take-Two's Red Dead Redemption 2 is proving to be a huge hit, the issues that dragged these stocks down related to their high valuations and the inevitability of inconsistent revenue in the video game business.

A full transcript follows the video.

This video was recorded on Nov. 9, 2018.

Chris Hill: Two video game stocks in the spotlight this week. Activision Blizzard's third quarter profits came in higher than expected. Second quarter revenue for Take-Two Interactive came in higher than expected. Despite those headlines, both of these stocks falling more than 10% this week.

David Kretzmann: Well, Chris, I think we can go to a little poem here to maybe explain what's going on. When the valuation is lofty, and growth is lumpy, Wall Street will be grumpy. That's my analysis for the day. I'll hang my head up there. No, anyways, Activision --

Hill: Wait, you wrote a poem?!

Kretzmann: I mean, I don't know if that counts as a poem.

Jason Moser: But you came up with that?

Kretzmann: I came up with it.

Moser: Between that and Twilification, there's some serious money being made by someone somewhere based on the IP that we're kicking out.

Jeff Fischer: Somewhere. And appification. It's a really clumsy word, but ...

Kretzmann: If this thing at The Fool doesn't work out, I'll start writing some more poems.

Fischer: [laughs] Robert Frost!

Kretzmann: Follow me on Twitter, everyone. [laughs] Anyways, going on to Activision. The quarter was pretty strong, but I think their guidance for the next quarter and the rest the fiscal year was just slightly below Wall Street expectations. By slightly, we're talking less than 5%. This quarter, they saw some key launches of their existing franchises, like Call of Duty with Black Ops 4, World of Warcraft, Candy Crush. Call of Duty, this latest version generated over $500 million in the opening weekend. That's a pretty strong release.

But going into this, like I mentioned in that poem, the company's valuation has been lofty over the past year or two. Now, after this drop, the stock is down about 13% or so, trading for around 21X forward earnings. From a valuation perspective, it's finally starting to get back into that reasonable range.

Hill: We've talked before about this industry being, like the movie industry, a hits-driven business. Is there one franchise in either of these companies that you look at and think, "Boy, if they can produce a big hit in this franchise, whether it's this holiday quarter or in 2019, it's really going to juice the stock?"

Kretzmann: For Take-Two Interactive, Red Dead Redemption 2 is their latest release. That just did phenomenally well. In the first eight days, Red Dead Redemption 2, which launched in October, sold more than the first Red Dead Redemption did and its first eight years. Red Dead Redemption 2 brought in $725 million over the opening weekend. So far, it's already sold over 70 million units globally. Packing a powerful punch right up there along Grand Theft Auto V, which for a long time has been the main revenue generator for Take-Two.

But this is a lumpy business. It's based on the timing of these releases. At the end of the day for these companies going forward, it's about how recurring can they make these releases. But so far, these steady franchises continue to do really well.