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How New Consoles Could Power Take-Two Stock to New Heights

By Will Healy – Jul 4, 2020 at 1:18PM

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Industry growth has driven both the next-generation consoles and Take-Two's game development.

Gaming stocks like Take-Two Interactive (TTWO 7.85%) are flying high as the COVID-19 pandemic left millions with both the time and inclination to play video games. But investors may have an excellent reason to follow Take-Two stock regardless of the coronavirus.

Industry analysts expect both Sony and Microsoft to release their next-generation game consoles during the upcoming holiday season. Those major hardware debuts, plus a growing interest in gaming overall, should help fuel a resurgence in both game sales and new releases.

A double-take on Take-Two

At the beginning of the year, few likely anticipated that a pandemic would drive an increased interest in gaming, and by extension, Take-Two stock. The company had seen lower profits as two of its games failed to meet "very high" expectations. In the quarter that ended on Dec. 31, net income fell 9% year over year.

However, Take-Two has become one of the few companies to benefit from the COVID-19 pandemic. Amid the lockdowns and sudden spike in unemployment, people suddenly had more time to devote to gaming. Take-Two stock fell in February and March along with the rest of the market, but it enjoyed a quick recovery. Net income for the fiscal fourth quarter (ended Mar. 31) more than doubled from the year-ago period. In the wake of these developments, Take-Two trades near all-time highs.

TTWO Chart

Data by YCharts.

Still, this rally may have obscured the short-term outlook for Take-Two stock. Thanks to the recent surge in the stock price, the company now trades at a forward price-to-earnings (P/E) ratio of 38. This is well above the average forward multiple of 30 over the last five years. The valuation has also moved ahead of its most direct competitors, Activision Blizzard and Electronic Arts.

Now that countries are easing lockdown restrictions, the higher P/E ratio may contribute to concerns that any heightened demand brought on by the pandemic will fade away, bring the stock down too.

Where the company will go next

However, investors may want to ignore the short-term effects of coronavirus on Take-Two stock, regardless of how much time consumers spend playing games when sheltered at home. Admittedly, this may make little sense at first glance. In the most recent earnings report, the company stated that it expects to earn between $344 million and $378 million in fiscal 2021. This is a significant drop from the $405 million net income of the previous year.

Nonetheless, investors need to look past the short term. Take-Two's numerous investments explain the temporary drop in profits. The company has a record 93 games under development for the next five years. This is the largest development pipeline in Take-Two history.

A young woman and young man sitting on a couch while playing a video game.

Image source: Getty Images.

Of the 93 new titles, updates from existing franchises will make up 47 of these games. However, with the coming console upgrade cycle, this makes sense. Moreover, the company describes 46 of these games as "new intellectual properties." One can assume some of these will go on to become new franchises in the future.

Additionally, the company will have an expanding customer base from which to draw. According to Grandview Research, the compound annual growth rate (CAGR) for the video game industry will reach 12.9% between 2020 and 2027. Hence, the growth in both Take-Two's profits and stock should continue regardless of how long coronavirus remains a factor.

Take-Two deserves a second look

Take-Two's rising multiple and temporarily falling profits should understandably concern investors. The uncertain effects that COVID-19 will have on the industry add to the worries.

However, the most crucial factor currently driving Take-Two stock is its bright future. Analysts forecast double-digit growth for the industry as new consoles sit on the horizon, and Take-Two is preparing for it all with dozens of new games in the works. Given these factors, Take-Two should move higher long-term regardless of any immediate uncertainty.

Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. Will Healy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Activision Blizzard, Microsoft, and Take-Two Interactive. The Motley Fool recommends Electronic Arts and recommends the following options: long January 2021 $85 calls on Microsoft, short January 2021 $115 calls on Microsoft, short January 2022 $75 puts on Activision Blizzard, and long January 2022 $75 calls on Activision Blizzard. The Motley Fool has a disclosure policy.

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