Many video game stocks skyrocketed throughout the pandemic as people stayed home and played more games. However, many of those gaming stocks also stumbled over the past year as their businesses faced tough year-over-year comparisons in a post-lockdown market.
Yet video games won't fade away anytime soon. The global gaming market is still projected to expand at a compound annual growth rate (CAGR) of 13.2% between 2021 and 2028, according to Fortune Business Insights, so investors should still consider gaming stocks to be solid secular growth plays.
Gaming stocks will inevitably face some near-term headwinds this year as rising interest rates and other macro headwinds rattle higher-growth tech stocks. However, I still believe Tencent (TCEHY 2.36%), Nvidia (NVDA -2.85%), and Nintendo (NTDOY 0.87%) could be worthwhile investments.
1. The turnaround play: Tencent
Over the past year, I've been reluctant to recommend Tencent -- the Chinese tech giant that is also the world's largest video game publisher -- as a viable investment for two main reasons.
First, unpredictable regulatory headwinds in China and the U.S. could lead to new fines, business restrictions, and even a delisting of Tencent's over-the-counter shares. Second, the Chinese government tightened online video game playtime restrictions for minors again and temporarily suspended the approval of new games last year. That pressure forced Tencent to rely more heavily on its seven-year-old blockbuster mobile game Honor of Kings.
However, the Chinese government recently softened its tone and said it would work with U.S. regulators to avoid potential delistings. It also started issuing new licenses for video games again this month. Meanwhile, the recent resurgence of COVID-19 in China recently sent several major cities into full lockdowns. Those draconian measures generated major tailwinds for online gaming companies two years ago.
These developments indicate it might finally be safe to buy Tencent, which lost about 40% of its value over the past 12 months. Analysts expect its revenue to rise 12% in 2022, but for its net income to dip 36% as it laps a big gain from its divestment of JD.com's shares in 2021.
In 2023, they expect its revenue and net income to grow 15% and 18%, respectively, as those year-over-year comparisons normalize. Based on those estimates, Tencent's stock looks cheap at just 18 times next year's earnings.
2. The growth play: Nvidia
Nvidia was one of the market's hottest growth stocks last year, but it tumbled nearly 30% this year as investors fretted over slowing PC sales in a post-lockdown market. However, the chipmaker still controlled 81% of the discrete GPU market at the end of 2021, according to JPR. AMD held the remaining 19%.
That dominant market share indicates Nvidia's GeForce GPUs still power the vast majority of gaming PCs across the world. Its Tegra SoCs (system on chips), which bundle together a CPU and GPU in a single package, also power Nintendo's Switch consoles.
Nvidia's total gaming revenue rose 37% year over year to $3.42 billion in its latest quarter and accounted for 45% of its top line. It was the company's second core growth engine alongside its data center business, which grew its revenue 71% year over year to $3.26 billion, or 43% of its top line.
Analysts expect its revenue and adjusted earnings to grow 29% and 27%, respectively, in fiscal 2023 (which started this January), as its gaming and data center businesses continue to grow.
That represents a slowdown from fiscal 2022, but its long-term prospects still look bright. More graphically advanced games will light a fire under its gaming GPU business again, while the growing usage of AI services will generate fresh tailwinds for its data center GPUs. Its stock also still looks reasonably valued at about 40 times forward earnings.
3. The value play: Nintendo
Nintendo's stock declined 28% in 2021 as investors fretted over its slowing growth in a post-lockdown market. It sold fewer Switch consoles, it struggled with the ongoing chip shortage, and it didn't launch any big blockbuster titles that could top 2020's Animal Crossing: New Horizons.
Last October, Nintendo's introduction of the Switch OLED -- which featured a better screen -- also disappointed some investors who had expected a brand new console to replace the original Switch from 2017. But this year, Nintendo's stock quietly advanced nearly 10% as other stocks struggled.
That's because investors rotated from growth stocks toward value stocks again as interest rates rose over the past few months. With a forward price-to-earnings ratio of 17, Nintendo was clearly a value stock again -- even though the company expects its revenue and net profits to decline 6% and 17%, respectively, in fiscal 2022 (which ended on March 31).
However, fiscal 2023 could be a much better year for Nintendo. Its upcoming releases for the year include new entries to well-known franchises like Pokémon Legends: Arceus, Kirby and the Forgotten Land, Splatoon 3, Sonic Frontiers, Bayonetta 3, and Metroid Prime 4. The ongoing expansion of its IP into movies, theme parks, apparel, and other retail merchandise could tether more customers to its brand and generate fresh licensing revenue.
Simply put, investors looking for a cheap gaming stock with evergreen franchises and plenty of growth potential should stick with Nintendo.