It's no secret that the video game industry has significantly evolved over the past few decades. From clunky old consoles with physical game cartridges to downloadable games, the industry has changed dramatically thanks to constant innovation.
But while the modes of gameplay have changed, many of the most popular franchises have shown a remarkable ability to stick around. Hit titles like Nintendo's (NTDOY 0.26%) Mario Brothers and Electronic Arts' (EA -0.46%) FIFA and Madden series have adapted to users' preferred gaming styles and progressed with the technology around them.
As the upcoming decade presents even more change, betting on both Nintendo and Electronic Arts is an easy way to capitalize on the dynamic video game sector.
Unlike most companies in the gaming space, Nintendo hasn't just been the recipient of technological change -- it's actually created it. Since Nintendo has almost always paired its games exclusively with its own hardware, the company has endured numerous boom and bust cycles. However, that process appears to be changing.
According to research firm NPD Group, Nintendo has been home to the best-selling video game console worldwide -- the Nintendo Switch -- for 34 of the last 35 months. But unlike with Nintendo's previous consoles, users' accounts are no longer tied to a specific piece of hardware. Instead, users can save their progress and content through their online memberships.
This digital focus also helps ease the transition across Nintendo's various Switch iterations. So as users upgrade from the original Switch to the Switch Lite, and now most recently to the Switch OLED model, they no longer need to restart from square one, but can instead save their progress and access games across different pieces of hardware. Not only does this encourage additional console upgrades and keep customers in the Nintendo ecosystem for longer, but it also makes Nintendo's game development process more lucrative.
As the company builds new downloadable games from its famous franchises like Pokémon, Zelda, Mario, and more, the active user base for Nintendo to sell to consistently grows. So far, Nintendo has sold more than 90 million total units of the Switch platform, and it has already touted 79 million playing users in the first half of this year alone.
With the upcoming slate of games containing several long-anticipated titles like Pokémon Brilliant Diamond, The Legend of Zelda: Breath of the Wild, and add-on content for Animal Crossing, Nintendo has upgraded its full-year guidance and expects to sell 200 million software units (game sales) for 2021 -- a 19% increase from its 2019 figure.
However, despite Nintendo's promising outlook, concerns over cyclicality and the company's risk-averse management team have hampered the stock price. Nintendo's current enterprise value (market cap minus net cash) to expected full-year operating income ratio stands at 9.1 -- far lower than those of many of its gaming peers.
Over the coming years, as Nintendo continues to add new iterations to the Switch platform and grow its active user base, its profits should trend steadily higher.
2. Electronic Arts
Electronic Arts, also known as EA, is a video game publisher that's most popular for its sports-based franchises FIFA and Madden. Over the last decade, while many of the company's prominent titles have stayed consistent, EA's business model has changed dramatically. Propelled by an industry-wide shift to live services, EA has become increasingly digital. In fact, prior to the introduction of live gameplay and digital downloads, EA generated most of its revenue through the sales of physical games. This meant that the value of a video game often stopped at the initial purchase. But that has since changed.
Since 2017, EA's bookings (money committed by customers but not entirely recognized as revenue yet) from live services have compounded by more than 35% per year, and in the most recent quarter accounted for 62% of the company's overall bookings. Additionally, more than 60% of the company's initial game sales are now completely digital. Since this requires less manufacturing and distribution costs, EA's per-unit profit margins have increased as well. This transition has helped EA improve its gross margins from less than 40% a decade ago to 73% in the most recent quarter.
But the company's growth isn't all in the past. In the most recent quarter, EA's trailing 12-month bookings jumped 27% versus the same period a year ago thanks in large part to the success of the company's new hit title Apex Legends. After first launching Apex Legends in 2019, the free-to-play shooter game has quickly risen to 100 million players and is fast approaching $1 billion in annual bookings. Additionally, EA's management team announced plans to build on that success by launching a mobile version of Apex later this year.
However, despite the enduring success that EA has demonstrated over the last decade, the company continues to trade at a favorable valuation. EA expects to generate roughly $2 billion in operating cash flow for the full year, but its market cap sits at just over $35 billion -- putting its enterprise-value-to-operating-cash-flow ratio at around 18 times. Management also appears to be cognizant of this attractive price, since it has repurchased $1.3 billion worth of its own shares over the last 12 months.
Between the company's timeless franchises, its promising development potential, and the stock's current valuation, investors should be in for quite a positive decade.