Nintendo (NTDOY -1.94%) released its fiscal fourth-quarter earnings at the end of April, which showed solid gains on the top and bottom lines for fiscal 2019 (which ended in March). However, management issued a soft outlook for the year ahead, which calls for just 4% growth in revenue and operating profit in fiscal 2020 -- well below the robust growth in fiscal 2019.   

Normally, investors frown upon weak guidance, but in this case, investors are still bullish on Nintendo. After an initial dip on the earnings news, the stock quickly rebounded and is up 31% year to date as of this writing.

It's apparent that investors believe Nintendo is going to outperform management's guidance -- here's why. 

Close-up of a person's hands holding a Nintendo Switch game system.


1. Analysts don't buy Nintendo's guidance

It's common in the video game industry for companies to issue conservative guidance only to beat their estimates down the road. Some analysts think that's exactly what Nintendo is doing now.

The company finished fiscal 2019 strong. Sales and operating profit soared 14% and 41%, respectively. The company sold 16.95 million units of Switch for the year, just shy of management's guidance of 17 million units. However, Nintendo experienced strong momentum in game sales through the holidays, selling 118.55 million software units for the year.

The company expects to sell another 18 million Switch units in the year ahead. Management also stated in the fiscal fourth-quarter earnings presentation that the Switch remains in a "growth phase" with software sales even stronger than hardware. Despite that, management's guidance calls for 125 million software unit sales this year, an annual increase of just 5%. 

The guidance for 125 million units doesn't make any sense given the fast-growing Switch installed base -- now at 34.74 million units as of Mar. 31, 2019. That should increase to over 50 million this year.

On top of that, the company continues to release compelling first-party titles. In the year ahead, Nintendo is perhaps releasing their strongest lineup yet, with a new Zelda, two Pokemon titles, Super Mario Maker 2, Luigi Mansion 2, and Animal Crossing. All these titles are based on Nintendo's most popular intellectual property, which will in turn drive healthy sales of hardware as well.

Given this context, management's guidance seems like a classic case of under-promise and over-deliver. Before the earnings release, analysts were expecting Nintendo to sell 161 million software units in fiscal 2020. 

2. Digital sales are booming

The video game industry has largely shifted to a digital distribution strategy, and Nintendo is positioned well to serve this channel. Management has made it a priority to release more in-game content in Nintendo's exclusive first-party titles, not to mention mobile game development. 

The efforts are paying off, as digital sales soared 95% year over year in fiscal 2019 and made up 25% of total sales. Last year's digital sales of 119 billion yen are more than six times the amount of digital sales generated in fiscal 2013. 

Additionally, Switch Online, a subscription service that gives console owners access to classic games for a monthly fee, is performing well with nearly 10 million subscribers on board. 

Finally, Nintendo's mobile game income grew 17% last year and made up 18% of the company's operating profit. Management continues to stay on track with their strategy to release two or three mobile games each year based on Nintendo's classic franchises. This summer the Japanese game maker is releasing Dr. Mario World and Mario Kart Tour, which should maintain momentum in digital sales.

3. Huge China opportunity

Nintendo made a big announcement recently that the Switch will be landing in China with the help of a partnership with Tencent. This is a significant development since China is the largest gaming market in the world. Chinese gamers should have a healthy appetite for Nintendo content, especially with the help of Tencent's marketing and distribution capabilities via its leading social media networks.

Specificially, Nintendo could see robust growth in mobile game sales, given the popularity of mobile gaming in China. One analyst with market researcher Newzoo called China "a massive opportunity for both Nintendo and Tencent." The analyst pointed out that Mario, Zelda, and Pokemon, are "extremely popular" with Chinese consumers. 

Management offered no timeline when Switch would launch in China and stated that Switch sales in that market aren't included in fiscal 2020 guidance. It may take a while for Switch to begin selling in the region. For one, Nintendo has to get regulatory approval to sell its games in the Middle Kingdom -- part of the government's new policy to crack down on video game content that is deemed "immoral" or violent. However, Nintendo shouldn't have a problem with this since the company's content is family friendly, but Chinese regulation is often a wild card.

A strong pipeline of new game releases, digital sales momentum, and the bright prospects Nintendo has in China are three reasons why the company's growth prospects are still bright despite management's conservative outlook.