One of the better-performing consumer discretionary stocks this year has been Japanese game-maker Nintendo (OTC:NTDOY). Following the recent release of its second-quarter earnings report, which trounced expectations, Nintendo’s stock is now up around 47% on the year in 2019.

Nintendo has been riding a wave of success on the back of its Switch console gaming system, which doubles as both a console and a hand-held device. Though it was first introduced some two years ago, the past quarter saw the introduction of two new models: a Switch with long battery life, and the handheld-only Switch-Lite.

In addition, Nintendo also released several big software titles for the Switch this year, including Super Mario Maker 2 in June, Fire Emblem: Three Houses in July, and The Legend of Zelda: Link's Awakening in September. The company also released two new mobile games, a smaller segment where the company has yet to gain much traction. These were Dr. Mario World in July and Mario Kart Tour in September.

A young gamer in glasses holds his Nintendo switch viewed from below with his eyes peering over.

Nintendo reported strong earnings. Image source: Getty Images.

The Switch is on fire, replacing the 3DS

In the six months ended in September, Nintendo recorded fantastic sales growth, spread evenly across Switch software and hardware.

Nintendo Segment

Growth, six months ended Sept. 30

Switch hardware units

36.7%

Switch software units

38.8%

Switch download digital software sales

83.0%

3DS hardware units

(62.9%)

3Ds software units

(58.5%)

Mobile sales

6.4%

Total sales

14.2%

Data source: Nintendo consolidated financial highlights. Table by the author.

As the figures indicate, the older Nintendo 3DS system is nearing the end of its life cycle, which began in February 2011.

While overall sales only grew 14.2%, strong software sales led to margin expansion, with operating profit increasing a whopping 53.4% over the year-ago period. Net income actually came in below that of last year’s period, but that was because of a large foreign currency charge due to the value appreciation of the Japanese yen.

But not all is perfect in Mario world

While the Switch platform is an undisputed success, it’s interesting that mobile sales only grew 6.4% year over year, despite the release of Mario Kart Tour, which was so popular at the outset that it broke Nintendo’s servers on its launch day. That’s likely because Mario Kart Tour came out just five days before quarter-end on Sept. 25, and operates on a “freemium” model, so players might not have had enough time with it to pay for in-game extra features that will be reflected in sales totals. Nintendo hasn’t had as much experience with mobile games as other companies, so it may take a while for the video game giant to figure out how to monetize mobile versions of its popular titles. Notably, the initial release didn’t include a multiplayer mode, but that should be coming shortly in a software update.

In addition to the tepid mobile growth, it’s somewhat confusing that, despite crushing first-half estimates, Nintendo management didn’t raise full-year guidance (its fiscal year ends in March of 2020). This could be mere conservatism on management’s part after 2018 Switch sales under-shot estimates.

Another reason could be that Japan increased its consumption tax from 8% to 10% starting in October, which likely pulled sales into the last few weeks of September. In fact, the company’s earnings presentation did note a surge in Switch sales in the two weeks prior to the end of September, before normalizing in the first three weeks of October.

bar graph showing weekly Switch sales surge at end of September and normalizing in October.

Image source: Nintendo.

Going forward

Nintendo now trades for about 30 times trailing 12-month earnings -- but remember, that includes a large foreign currency charge that dramatically hit net income this quarter.

Aside from that and the monetization issues around mobile gaming, most of Nintendo’s business is quite strong. Switch sales are up, as are related software sales coming from Nintendo’s “evergreen” franchises like Super Mario, Zelda, Pokemon, and Fire Emblem. The current quarter will also see several new titles launch for the holiday season, including Luigi’s Mansion 3, Pokémon Sword, Pokémon Shield, and Ring Fit Adventure, a new Switch game with an aerobics element.

This consistent innovation around beloved franchises and characters should keep Nintendo’s stock heading upward, as we are still only in year three of the Switch console cycle and console cycles usually last 10 years or so.