The COVID-19 pandemic and the resulting work-from-home trend have accelerated the growth of the video game industry in the last few months. Companies are seeing more players join the gaming fold, and with advancements in graphics technology on the horizon with the new consoles coming this fall from Sony and Microsoft, now is a good time to consider adding a few top video game stocks to your nest egg.
Here are three video game stocks that should deliver good returns over the long term.
1. Activision Blizzard: High P/E, but the valuation is justified
CEO Bobby Kotick has guided Activision Blizzard (ATVI -0.71%) to market-beating returns since taking over in the early 1990s. Over the last 10 years, the stock is up 590%, well ahead of the S&P 500 return of 185%. The next 10 years look just as promising.
Activision enters the new decade with momentum. Two of its bellwether franchises are firing on all cylinders, with recent releases from Call of Duty and World of Warcraft driving higher levels of player engagement. The combined revenue from the Activision Publishing and Blizzard segments, which operate those two franchises, increased by 47% year over year to reach $971 million in the first quarter.
Activision Blizzard is home to many popular franchises, including Overwatch and the mobile game Candy Crush. Along with other growing revenue streams from esports, consumer products, and advertising, it generated $6.4 billion in revenue over the last four quarters and $1.4 billion in free cash flow.
For the next phase of the company's growth, management is beginning to pursue the fastest-growing market in the video game industry, mobile gaming. Activision acquired King Digital Entertainment in 2016 for $5.9 billion, which laid the foundation for its mobile future with the top-grossing Candy Crush franchise. Management has a broad strategy in place to create mobile versions of existing franchises, such as Call of Duty and Diablo.
Activision expects modest growth in 2020. Based on full-year earnings guidance of $2.62 per share, the stock currently trades for a price-to-earnings multiple of 27.5. The shares are not a bargain, but in an industry with so much opportunity for growth, the valuation seems justified.
2. Zynga: Growing fast in the right markets
In the earlier part of the last decade, Zynga (ZNGA) stock was a roller coaster. Investors bid the shares up to high valuations amid a fast-growing mobile game market, and it took a while for the business to catch up to the high expectations embedded in the share price. But Zynga has settled into a groove over the last few years, and the stock has soared.
It owns an impressive roster of titles, such as CSR Racing, FarmVille, Merge Dragons!, Merge Magic!, Words With Friends, and Zynga Poker, among others, that altogether generated $1.46 billion in revenue over the last four quarters. In the last five years, revenue has nearly doubled, but growth has accelerated over the last few years, thanks to additional revenue from acquired games and new releases.
Zynga has successfully used acquisitions to grow its revenue and free cash flow to reward investors. The latest purchase, just announced on June 1, is the biggest yet. Zynga is acquiring the Istanbul-based mobile game maker Peak for $1.8 billion, which will increase daily active users by 60% while adding two of the top-grossing mobile games, Toon Blast and Toy Blast. The deal is expected to close in the third quarter.
Management expects full-year revenue to increase by 28% to $1.69 billion, while adjusted EBITDA is expected to more than double to $223 million. The stock currently trades at 32 times forward earnings estimates. This is definitely a gaming stock you will want to own because it's growing fast in a mobile-game market that is estimated to reach $77 billion this year.
3. Take-Two Interactive: Making investments that should pay off
Take-Two Interactive (TTWO 0.39%) is known for the Grand Theft Auto franchise and the popular NBA 2K basketball series, but it has a deep roster of titles, including Bully, L.A. Noire, Max Payne, Red Dead Redemption, Borderlands, BioShock, and Sid Meier's Civilization. In fiscal 2020, which ended in March, Take-Two generated just over $3 billion in revenue and $632 million in free cash flow.
The company has performed exceptionally well over the last decade. Grand Theft Auto V has sold an impressive 130 million copies since its launch in 2013. In 2017, Take-Two acquired the mobile-game maker Social Point for $250 million, which establishes an entry into the burgeoning mobile game market.
The stock has delivered stellar returns of 1,110% over the last 10 years. While it might be difficult to repeat that success over the next decade, Take-Two is embarking on an ambitious strategy to increase its scale by releasing dozens of new titles over the next five years, many of these from existing franchises, which should improve the chances that these new games find a large audience and eventually grow profits.
Management expects the light release slate in the short term to contribute to lower revenue in fiscal 2021. Plus, the company is ramping up investment in its upcoming releases, which will pressure margins, but now is the time to buy shares. The stock currently trades at 35 times forward earnings estimates. That looks high, but keep in mind that near-term earnings will be down due to higher operating expenses to invest in new games, which makes the stock look more expensive.
Management expects the new games over the next five years to not only grow revenue but also improve operating margin, which should lead to higher earnings over time.
The potential is great
The video game industry is expected to grow 9.3% in 2020 to reach $159.3 billion, according to market researcher Newzoo. The COVID-19 pandemic is accelerating the trend toward interactive entertainment, as more people discover the value of spending up to $60 for a new game that delivers dozens of hours of entertainment, in addition to the countless games that are free to play. There is still a lot of potential for the three companies featured here to reward investors over the long haul.