GameStop's (GME 2.50%) historic short squeeze, which caused the video game retailer's stock to skyrocket over 1,900% between Jan. 1 and Jan. 27, captivated -- and burned -- many investors. The bubble eventually popped, but the stock remains up more than 200% for the year.
Those gains don't have much fundamental support. GameStop's sales of physical games are still sliding as gamers rely more on digital downloads, while big box retailers also sell the latest hardware. The coronavirus pandemic also exacerbated that pain over the past year.
GameStop's revenue fell 31% year over year in the first nine months of 2020, and it remained unprofitable. It expects its comparable store sales to rise in the fourth quarter as it sells new consoles and closes weaker stores, but analysts still expect its revenue to drop 19% for the full year, and for its bottom line to remain in the red.
Image source: Getty Images.
Instead of joining the speculators and betting on GameStop's longshot turnaround, investors should buy a better video game stock with a brighter future: Nintendo (NTDOY +3.20%).
Nintendo's core strengths
Nintendo has shipped 79.9 million Switches globally since the console's launch in early 2017. By comparison, Microsoft (MSFT +0.60%) and Sony (SNE +1.12%) have shipped an estimated 49.6 million Xbox Ones and 114.9 million PS4s, respectively, since their launches in late 2013.
The Nintendo Switch established a strong market presence for three reasons. First, the Switch can be used as either a handheld device or a console docked to a TV. That unique form factor leveraged the strengths of Nintendo's earlier handhelds (including the Game Boy and 3DS) to challenge Microsoft and Sony in the home console market.
Second, Nintendo launched plenty of exclusive first-party games for the Switch, including Mario Kart 8 Deluxe, Animal Crossing: New Horizons, Super Smash Bros. Ultimate, The Legend of Zelda: Breath of the Wild, and Super Mario Odyssey. Gamers needed to buy a Switch to play those games, while many popular Xbox One and PS4 games were cross-platform titles that were also available on PCs.
Lastly, Nintendo continued to refresh the console to attract new customers. In 2019, it upgraded the original Switch with a new chipset that extended its battery life, then launched the cheaper handheld-only Switch Lite for budget-conscious consumers.
Image source: Nintendo.
How fast is Nintendo growing?
Nintendo's sales surged 116% in fiscal 2017, thanks to the Switch's arrival, and rose 14% in 2018 and another 9% in 2019.
Nintendo's growth has been decelerating, but it expects its sales to rise 22% in fiscal 2020, which ends in late March, buoyed by strong sales of the Switch, Switch Lite, and its first-party games.
Standout games include Animal Crossing: New Horizons, which became a virtual social platform throughout the pandemic; Paper Mario: The Origami King; Super Mario 3D All-Stars; and Mario Kart Live: Home Circuit, which lets players race through AR tracks at home with radio-controlled cars.
Robust sales of the Switch boosted Nintendo's operating margin from 6% in fiscal 2016 to 26.9% in 2019, and it expects that ratio to hit 35% in 2020. That margin expansion caused Nintendo's net profit to rise 36% in fiscal 2017, 39% in 2018, and another 33% in 2019. It expects that streak to continue with 55% profit growth in fiscal 2020.
Why Nintendo still has room to run
Nintendo's growth rates look fantastic, and its stock has already risen more than 60% over the past 12 months. But I believe it can still head even higher, for a few simple reasons.
Nintendo's ADR shares only trade at 19 times next year's earnings. The stock remains cheap because analysts expect Nintendo's revenue and earnings to dip 4% and 2%, respectively, next year, presumably as it faces tough year-over-year comparisons and fresh competition from Sony and Microsoft's newest consoles.
But those estimates could be too low, and probably don't factor in the potential launch of a "Switch Pro" model in 2021 or the resilience of its hybrid form factor and first-party games against the PS5 and Xbox Series S and X consoles. Those tailwinds could help Nintendo easily clear Wall Street's low expectations -- and force analysts to raise their conservative estimates.
The key takeaway
GameStop's bulls often claim robust sales of the Nintendo Switch, which runs some of its games on physical cartridges, will bring more shoppers to its stores. That might happen, but it's smarter and safer to simply buy shares of Nintendo to ride that trend instead of taking a big risk on GameStop's wild stock.
