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3 Stocks to Invest in the Future of Video Games

By Nicholas Rossolillo - Dec 19, 2020 at 8:00AM

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Expect big things from two companies that provide key tech for VR, the cloud, and high-quality graphics. And don't underestimate the power of the one that delivers the familiar brands.

The video game industry had a great year in 2020. With people spending a lot more time at home than usual due to the pandemic, many shelled out for new hardware and titles, which sent some video game stocks soaring. But the industry is far from spent, and advances in underlying technology could keep the party going for years.

Three players in the video game industry that look like buys to me right now are NVIDIA (NVDA -6.82%), Skyworks Solutions (SWKS -4.74%), and Disney (DIS -4.00%).

1. NVIDIA: This hardware upgrade cycle is only just beginning

I'm not shy about revisiting my favorite semiconductor stock again. Its shares have more than doubled this year as a new hardware upgrade cycle is underway, and it doesn't look as if it will slow down anytime soon. NVIDIA's graphics processing units (GPUs) are getting put to a host of uses -- in autonomous vehicle systems, in industrial robotics, and in data centers, just to name a few. 

Someone wearing a virtual reality headset.

Image source: Getty Images.

NVIDIA's GPUs may have a myriad of applications, but their utility was born out of the company's efforts to support high-end video game graphics. And though the GPU designer has grown up, gaming remains its largest end-market -- even after it completed its acquisition of data center networking company Mellanox this spring and released a slew of new chip designs aimed at the cloud computing industry. With $2.27 billion in video game revenue during its third quarter alone (good for 48% of total sales), it might seem like sales into this segment would be played out. But the 37% year-over-year increase would indicate otherwise.  

Its latest high-end GPUs for PCs and laptops, the RTX 30 series, have been in short supply since they became available in September. NVIDIA is making ray-tracing technology the new standard for gaming, and it will take a long time for a majority of the millions of computer gamers worldwide to upgrade their rigs. Supply of the RTX 30s is expected to be short well into 2021, prolonging the recent run-up in the company's largest sales segment.

Along with new hardware, NVIDIA has its cloud-based video game streaming platform GeForce Now, which unlocks next-gen performance for all the gamers out there who aren't playing on expensive computers.

NVIDIA is certainly not cheap. It's trading at 78 times free cash flow (revenue minus cash operating expenses and capital expenditures), but it carries a hefty premium for good reason. It's a technology leader in gaming, and it's using its work in that arena to rapidly expand its footprint into many other industries. This stock will remain a core holding in my portfolio for the long haul.  

2. Skyworks Solutions: Time to ditch all those wires

Mobility is another key ingredient in the future of gaming. The smartphone boom of the 2010s made casual on-the-go gamers out of hundreds of millions of people, to Skyworks Solutions' benefit. The company supplies connectivity chips for phones, and the next-gen 5G mobile network upgrade cycle is just starting to yield rich results for it. Revenue increased 16% year over year during Skyworks' fiscal 2020 fourth quarter, which ended Oct. 2.  

5G could open up plenty of new use cases for mobility -- including for video games -- but Skyworks has a lot more going for it than a new smartphone upgrade cycle. WiFi 6, which enables faster wireless speed and more data traffic from devices, is an oft-overlooked technology that is also propelling this chip designer's business higher. Not only are internet networks (like WiFi 6 routers for homes and offices) in the early stages of updating, but so are devices that can utilize WiFi 6. And video game nerds (myself included) have been some of the earliest adopters of this tech.  

Speaking of devices, Skyworks' tech can also be found in Facebook's Oculus Quest 2 virtual reality headset. The unit is freestanding -- not tethered to a gaming PC or laptop -- and connectivity chips from Skyworks help make that wireless VR experience possible. Also of note this year were new high-end audio headsets (also getting put to use by gamers) from the likes of Logitech. Skyworks was also tapped to power those devices' wireless connectivity.  

While smartphones remain the company's bread and butter, its sales for other electronics are growing rapidly -- up 30% sequentially for Skyworks' fiscal Q4 to nearly a third of total revenue. As mobility steadily expands beyond phones, and advances in gaming capabilities continue, this semiconductor stock looks like an excellent investment. Skyworks currently trades for 31 times trailing 12-month free cash flow.  

3. Disney: A top licensor of video game content

My final pick is a departure from the hardware realm, and it isn't a major game producer either. Rather, Disney is a top licensor of content.

The entertainment giant owns both Marvel and Star Wars producer Lucasfilm -- two brands featured in a number of recent top-selling games. In 2019, Electronic Arts' Star Wars Jedi: Fallen Order was in the top 10 list of titles sold, and its sales momentum carried over into 2020. EA has another hit on its hands with the October 2020 release of Star Wars Squadrons. And though Square Enix's Marvel's Avengers video game has received mixed reviews, it will still likely be a top-10 seller in 2020 too. For Disney, any sales at all are a good thing (since it doesn't have to worry about production costs).

Disney hasn't been shy about wanting more video game producers to experiment with its catalog of intellectual property, which is now larger than ever after the acquisition of Fox and its famous franchises including Alien, Avatar, and Terminator. That doesn't even touch on the less violent content that could be put to use in the years ahead. Given the uncertainty facing the entertainment industry when it comes to the future of movie theater screenings, I think video games are destined to become a more important part of Disney's empire.  

As for the "parks, experiences, and products" reporting segment, the closures and restrictions of Disney theme parks have sent what was once its largest operation into precipitous freefall. Revenue was down 61% year over year during the company's fiscal fourth quarter. "Studio entertainment" was down 52% in the same period. But beyond a gradual recovery of travel and an easing of movie theater restrictions, Disney's expansive library of content can pull some weight in a new and big way. After all, video game sales are expected to be in the ballpark of $160 billion globally this year. Disney already has a template for success. It wouldn't be a stretch to imagine it going after a bigger slice of that lucrative market with its content-licensing business.

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Stocks Mentioned

NVIDIA Corporation Stock Quote
NVIDIA Corporation
NVDA
$169.38 (-6.82%) $-12.39
Skyworks Solutions, Inc. Stock Quote
Skyworks Solutions, Inc.
SWKS
$101.79 (-4.74%) $-5.06
The Walt Disney Company Stock Quote
The Walt Disney Company
DIS
$104.30 (-4.00%) $-4.34

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