Top video game stocks have outperformed the broader market for decades, and the ongoing advancements in gaming technology will only continue to push the industry forward.  

It's estimated that as many as 3 billion people worldwide will be playing games in some form by 2023, keeping the video game industry on pace to grow around 10% per year. This is a major tailwind for top game producer Activision Blizzard (ATVI) and the online platform Roblox (RBLX 1.83%)

Let's see which of these growth stocks offers the best balance of risk and reward.

A lineup of avatars available on Roblox.

Image source: Roblox.

Growth comparison 

Roblox is sort of like a social media platform and video game company rolled up into one. It boasts 37 million daily active users that come to Roblox every day to connect with friends, play games, or engage in educational activities, but management sees the potential to expand its use cases beyond these areas over time. 

It has grown faster than Activision over the last two years. Bookings (a non-GAAP measure of revenue) nearly tripled in 2020 to $1.9 billion, as the average user spent 2.6 hours per day on the platform and purchased additional content through microtransactions.  

However, last year's stellar results were inflated due to the stay-at-home environment. In 2019, Roblox increased bookings 39%. Management expects bookings growth to slow to single digits this year before resuming stronger growth in 2022. 

Activision hasn't expanded as fast as Roblox over the last few years, but it has delivered enough growth in bookings, earnings, and free cash flow to fuel better-than-average returns for investors. Activision's bookings have nearly doubled since 2015 and accelerated to a growth rate of 32% in 2020. Those results fueled a 302% increase in Activision's stock price over the last six years, significantly beating the broader market. 

ATVI Chart

ATVI data by YCharts.

Activision is a proven cash producer

One drawback for Roblox is that it just went public in March, so we don't have a lot of financial history on the company. But Activision has been producing consistent free cash flow and paying an annual dividend since 2010. Last year, the Call of Duty maker generated $2.1 billion in free cash flow and paid 14.5% of that total in dividends, bringing the current dividend yield to 0.51%. 

To its credit, Roblox could grow into an elite cash producer, too. It generated $411 million in free cash flow in 2020, which is roughly a quarter of its total bookings -- a very healthy free cash flow margin. But Roblox needs to invest in infrastructure and compensating the developers on its platform to keep growing, which could pressure its profitability over the next few years. 

Last year, the company paid out $328 million in developer exchange fees, which are Roblox's largest operating expense. Management expects adjusted cash from operations to decline to a range between $371 million and $391 million in 2021, excluding one-time expenses related to its direct listing. 

Activision has less business risk

Roblox is a promising growth stock. Just consider Activision's 397 million monthly active users. That's over 10 times the average daily user base of Roblox, which shows that there are a lot of gamers out there that could potentially engage with Roblox's platform.

Still, Activision saw nearly 100 million new users join its player network following the release of Call of Duty: Mobile in October 2019. Management believes it can reach 1 billion monthly active users over the long term. Activision has a few catalysts on the horizon, with upcoming releases in its Diablo and Overwatch franchises. Plus, Activision is more diversified across mobile, console, and PC. Last year, it generated more than $2 billion in revenue across each of these platforms. 

Meanwhile, 72% of Roblox's users access the platform on mobile devices, which presents more competitive challenges given the fickle nature of some mobile users. For example, Activision has been bleeding users in its Candy Crush franchise for several years as less-engaged players leave the base. That hasn't hurt Activision thanks to its diverse game catalog and recent efforts to better monetize its mobile users through in-game advertising. But it just goes to show that Roblox's future growth path is far from certain. 

Overall, I like Activision's balanced revenue generation across all the major gaming platforms.

Go with the proven winner

Investors are paying a high price for growth right now. Roblox shares currently trade for a steep price-to-sales ratio of 42. Here's how the stocks compare on valuation and expected growth based on bookings guidance for 2021.

Metric Activision Blizzard Roblox
Market cap $72 billion $39 billion
P/S ratio 8.9 42.2
Price-to-free-cash-flow ratio 33.3 94.9
Expected bookings growth (2021) 0.4% 6%-13%

Data sources: YCharts and the companies.

Activision's P/FCF ratio of 33 is not cheap, and it's possible both stocks may have limited near-term upside given the relatively low growth expected in 2021. It will take a year or so for both companies to lap the high engagement trends experienced during the pandemic and resume a normal growth pattern.

I would still favor Activision because it operates some of the most popular gaming franchises in the market and has a massive player network of 397 million monthly active users. The company has a multi-year record of delivering outstanding operating results and paying annual dividends. For these reasons, I believe Activision Blizzard is the better investment if you're looking for a relatively safe video game stock.