Sea Limited (SE 2.03%) and Activision Blizzard (ATVI) are both well-known gaming companies. Sea's Garena publishes Free Fire, which App Annie ranked as the world's most downloaded mobile game last year. The battle royale game has locked in more than 100 million daily active users, many of whom are located in Southeast Asia and Latin America.

Activision Blizzard, one of the world's largest gaming companies, owns three publishers: Activision, which is best known for its Call of Duty titles; Blizzard, which publishes games like Overwatch, Diablo, World of Warcraft, and Hearthstone; and King, which conquered smartphones with Candy Crush.

A PC gamer plays a game.

Image source: Getty Images.

Both companies fared well throughout the pandemic last year as stay-at-home measures prompted people to play more games. But Sea also owns Shopee, the top e-commerce company in Southeast Asia and Taiwan -- so it also benefited from pandemic-induced online shopping.

Sea's stock surged more than 160% over the past 12 months as it dazzled investors with its robust revenue growth and improving adjusted EBITDA. Activision's stock only advanced about 20%, even though the gaming giant's hits easily outweighed its misses.

Sea clearly generated more impressive gains, but will it stay ahead of Activision as investors abandon many hyper-growth stocks? Let's take a fresh look at both companies to decide.

Sea offers incredible growth...with incredible risk

Sea generated half its revenue from its e-commerce business last year. Its digital entertainment (gaming) business accounted for 45% of its revenue, while the remaining 5% came from its fintech business.

Sea's revenue surged 101% to $4.4 billion last year as its e-commerce and digital entertainment revenues soared 160% and 78%, respectively. Analysts expect its total revenue to rise another 90% this year.

That outlook seems rosy, but Sea remains unprofitable on a GAAP basis, and its near-term adjusted EBITDA growth relies entirely on Free Fire, Garena's first self-published hit. Prior to Free Fire's launch in 2017, Garena mainly generated lower-margin revenue from licensed games.

Free Fire's growth boosted the digital entertainment unit's adjusted EBITDA 94% to $1.98 billion in 2020, which barely offset the widening losses at its e-commerce and fintech segments.

As a result, Sea squeezed out an adjusted EBITDA of $107 million for the full year, compared to a loss of $179 million in 2019. Analysts expect Sea to gradually narrow its losses over the next two years.

Sea's long-term future relies on three main things: the longevity of Free Fire, Garena's ability to launch more hit first-party games, and Shopee's ability to narrow its losses per online shopper while staying ahead of Alibaba's Lazada across Southeast Asia.

If Sea achieves those three goals, it could continue to generate dazzling growth for years to come. But if Garena loses its momentum before Shopee's adjusted EBITDA turns positive, Sea's stock -- which certainly isn't cheap at 18 times this year's sales -- could have a long way to fall.

Activision offers balanced growth... with fewer catalysts

Activision grew at a much slower rate than Sea last year. Its revenue rose 25% to $8.08 billion in 2020, and its net income increased 46% to $2.2 billion. Its non-GAAP EPS increased 39%.

A father and son play a video game at home.

Image source: Getty Images.

Activision's flagship Call of Duty franchise drove most of the company's growth throughout the pandemic. King kept mobile gamers engaged with newer versions of Candy Crush, but Blizzard's aging titles -- namely World of Warcraft, Overwatch, and Hearthstone -- attracted few gamers.

At the end of the first quarter of 2021, Activision had 150 million monthly active users (MAUs), Blizzard had 27 million MAUs, and King had 258 million MAUs.  Activision's 47% year-over-year growth in MAUs, which mainly came from Call of Duty, offset its declines at both Blizzard and King during the quarter.

Wall Street expects Activision's revenue and non-GAAP earnings to rise 4% and 8%, respectively, this year. Call of Duty could face tough year-over-year comparisons this year as the pandemic passes, while the newest expansion packs for World of Warcraft and Hearthstone should only help Blizzard tread water instead of swim forward.

Blizzard recently launched Diablo Immortal, but the mobile entry to its flagship Diablo franchise could attract fewer gamers than its PC-based predecessors. Blizzard could also launch Overwatch 2 next year, but it still hasn't set a firm release date for the eagerly anticipated sequel.

In other words, the rest of 2021 could be tough for Activision Blizzard as its core growth engines stall out and its weaknesses become more apparent. That's why its stock underperformed Sea's -- and why it still looks fundamentally cheaper at 21 times forward earnings and eight times this year's sales.

The winner: Sea Limited

I bought more shares of Sea last month after its first-quarter earnings report for three main reasons: Shopee's growth was accelerating with lower adjusted EBITDA losses per order, Free Fire was still "on fire," and it remains cheaper than other "hyper-growth" stocks.

Activision's business is solid, but there aren't enough good reasons to buy its stock as its growth decelerates this year. Therefore, I'd rather take a chance on Sea than tread water with Activision.