The growth of interactive entertainment is a ripe field to look for growth stocks, but some investors may not realize that the leading game makers are so profitable that they make great income investments too. Video game companies spend relatively little on capital expenditures, which leads to plenty of free cash flow to fund rising dividends to shareholders.
With more people continuing to play video games, investors should consider shares of Activision Blizzard (ATVI +0.00%) and Electronic Arts (EA 0.09%). These two companies are leaders in the industry, pay dividends, and should deliver above-average returns over the long term.
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1. Activision Blizzard
Activision owns some of the most popular intellectual property in the industry. It ended 2020 with 397 million monthly active users across all its games, including its top three money makers: Call of Duty, World of Warcraft, and the mobile game Candy Crush.
The company is targeting 1 billion users over the long term, as management pursues a strategy to produce more content updates for existing games and launch mobile versions of its most popular franchises. This strategy is already leading to great results, with Call of Duty generating a record $3 billion in bookings last year, making up 36% of Activision Blizzard's business.
Selling games has become a highly profitable business. Last year, Activision Blizzard converted $8.4 billion in bookings to over $2.1 billion in free cash flow. Out of that cash flow, Activision paid $316 million in total dividend payments in 2020.
Unlike most dividends stocks that distribute a quarterly payout, Activision pays its dividend annually. The company first initiated a dividend in 2010 and has increased it every year since. The next dividend comes to $0.47 per share and will be paid on May 6 to record shareholders as of April 15. That represents a dividend yield of 0.49% at Activision's current stock quote of $95.
Activision's current yield is well below the average stock dividend yield of 1.46%, based on the SPDR S&P 500 exchange-traded fund. However, Activision's low cash payout ratio and ability to generate consistent free cash flow every year should lead to steady increases in the dividend over the long term.
ATVI Total Return Price data by YCharts
2. Electronic Arts
EA is best known for its EA Sports titles, most notably FIFA and Madden. The business of selling sports games is a very lucrative one. These franchises get updated every year with new features that drive repeat purchases from fans, which creates a recurring revenue stream.
Over the last four quarters, EA generated $1.9 billion in free cash flow from $5.9 billion in bookings. The company just initiated its first dividend at a quarterly payout of $0.17 per share. That represents an annual dividend yield of 0.49% at the current quote of $137.
The announcement of EA's first dividend is a great sign for the future. It means the business is generating more cash than it needs to fund operations, and management believes that profits will be sustainable and continue to grow over time.
EA sees similar opportunities as Activision Blizzard. There are more than 230 million players in the EA Sports network. Over the next five years, management believes it can grow the player base for its sports titles, including viewers on live game streaming sites, to 500 million.
EA recently put some of its $6.7 billion of cash and short-term investments to work with the $1.2 billion acquisition of Codemasters, along with the recently announced deal to buy Glu Mobile (GLUU +0.00%) for $2.1 billion. These deals add top racing franchises and mobile games that will pad EA's bottom line, potentially setting up an increase in the dividend next year.
Trends driving growth in gaming
Improving graphics technology and internet speeds are fueling the growth of interactive entertainment, as more people are turning to games to socialize and play with others in multiplayer game modes. Market researcher Newzoo expects the global gaming population to increase 5.6% per year to over 3 billion players by 2023.
Activision and EA are in a great position to attract more players with their marketing and global distribution capabilities. These are advantages that are unique to the biggest video game companies that have billions in cash to invest in new content and market their titles to players around the world. The dividends that Activision and EA pay only sweeten the deal.
