GameStop (GME 2.56%) has become a viable turnaround candidate despite its meme stock status.
Just one year ago the video game retailer was looking more like it was heading toward bankruptcy than a renaissance. Despite several activist investors sniffing around the dying carcass, the chances were high that GameStop was little more than a cigar-butt stock, an investment that had a few more puffs left to it before it got stubbed out.
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The value of a fresh start
However, as it limped into 2021, the clouds began to break. Holiday sales came in stronger than expected, and activist investor Ryan Cohen was given three seats on the board of directors. GameStop's stock also began to surge, leading to an unprecedented epic battle between hedge funds and retail investors.
While the "hedgies" were shorting GameStop's stock to the max, internet chatrooms were rallying investors to buy the video game stock's shares to drive the price higher and launch a short squeeze. And it worked.
GameStop's stock at one point soared 1,800%, putting a mighty hurting on short sellers. It also allowed the retailer to sell more stock to raise money, ultimately letting it pay off all of its long-term debt and giving it a substantial war chest of over $707 million to become a viable business again in the future. It's a battle retail investors are now trying to replicate with other meme stocks.
I no longer think an investment in GameStop is a losing bet (at least not at a reasonable price -- valuation still matters), and that it has potential to become the "Amazon of gaming." But investors should really consider putting their money in these three gaming stocks instead, as they have a lot more growth potential ahead of them without the same risk.
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1. Sea Limited
Singapore-based Sea Limited (SE -0.69%) is a diversified company with three arms: an e-commerce company, a digital financial services platform, and its oldest business, digital gaming, which also happens to be its most profitable.
Sea's first-quarter results showed digital gaming generated $717 million in adjusted earnings before interest, taxes, depreciation, and amortization, while e-commerce showed an adjusted loss of $412 million and digital financial services had a $153 million adjusted loss.
Yet all three segments are growing rapidly, and while the digital entertainment segment certainly benefited from people being stuck at home during lockdowns, today it is still seeing sales grow. In the first quarter they more than doubled to $781 million, and the other segments saw even better gains, outstripping the rate at which their losses widened as the company invested heavily in each.
Quarterly active users (QAU) jumped more than 61% from the year-ago period to hit 648.8 million, and they were up over 6% sequentially.
Gaming is Sea Limited's growth engine, but coupled with the potential for its e-commerce platform Shopee and its SeaMoney digital financial services business, Sea's long-term prospects look especially bright.
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2. Skillz
Esports is going to be huge. It's already big, but it's expanding rapidly, with global revenue expected to reach almost $1.1 billion in 2021, a 14.5% gain from last year. Of that amount, Newzoo forecasts more than 75% of that figure, or $834 million, will come from media rights and sponsorships. That serves Skillz (SKLZ -0.95%) perfectly.
Skillz is a gaming platform providing an arena in which gamers compete against each other for cash prizes. Then it and the game developers get to split a portion of those prizes. Since it is game-neutral and doesn't have the expense of actually having to develop games, and then follow them up with another and another and another, Skillz is able to generate monstrous profit margins.
First-quarter gross margins were an astounding 95%, a 100-basis-point increase over the year-ago figure. It also nearly doubled revenue (up 92%), marking the 21st consecutive quarter it has reported revenue growth, while raising its full-year revenue guidance to $375 million in revenue, a 61% increase from 2020.
Esports is one of the fastest growing niches, and there's even the potential that betting on competitive play will cause it to accelerate its growth even more. Major corporations are backing esports teams and leagues, sponsoring events, and putting up cash prizes. Skillz could be one of the hottest tickets around to capitalize on the opportunity.
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3. Electronic Arts
The video game industry has had a whirlwind time. The start of the video game console upgrade cycle began just prior to the pandemic, and the pandemic itself gave it a major boost as gamers were shut in with nowhere to go. Mobile gaming also cemented its leadership position as the growth engine for the industry.
Video game stalwart Electronic Arts (EA -0.65%) also marched higher, and though its shares remain nearly 60% above where they were at the start of the pandemic, that's really just a continuation of the recovery it has been on since the beginning of 2019.
Admittedly, EA was slow to recognize the potential for the mobile market, with mobile games comprising just 13% of fiscal-fourth-quarter revenue. But now it is making up for lost time. In April it announced it was acquiring Gluu Mobile for $2.1 billion, and last week said it was buying Playdemic for $1.4 billion.
EA can afford to buy these businesses because it is a cash-generating machine, with over $1.8 billion in free cash flow over the last 12 months. It also pays a modest dividend of $0.68 per year that currently yields under 1%.
Electronic Arts is a solid business, a respected name in the industry with more than its share of top-selling games, and now it is bringing the full weight of its business into the biggest growth market in the industry. Look for this video game stock to generate years of sustained growth for investors.
