After outperforming the major indexes for most of the last decade, shares of top video game producer Take-Two Interactive (TTWO 0.21%) have trailed the market over the last three years. The stock is currently at the same level it traded at this time in 2019, while the S&P 500 index is up more than 40% in the same period.
Over the last 10 years, the success of Take-Two's Grand Theft Auto V led to phenomenal returns for shareholders. A $1,000 investment in 2012 would be worth over $12,000 today.
The stock's underperformance this year parallels the slowdown in the industry. Market researcher Newzoo expects total industry sales to be up just 2% in 2022. But looking further ahead, market experts see more growth coming, thanks to a massive pool of 3.2 billion gamers worldwide.
Take-Two's strategy involves expanding its game roster to cast a wide net for a larger audience, but that's not all it has going for it. Not only can Take-Two grow in line with the industry, which averaged around 10% annualized growth over the last 10 years, but the company can do better given its record for expanding game sales across its biggest franchises.
Take-Two's track record of game sales
Take-Two's most popular game is Grand Theft Auto. The first installment in the series originally launched in the 1990s, and each installment since then has generated bigger sales.
Cumulative sales of the franchise stand at 380 million copies, according to Statista. Grand Theft Auto V (2013), the latest iteration in the series, is responsible for roughly half of the franchise's lifetime sales, selling 170 million copies through the most recent quarter.
Investors should expect Grand Theft Auto VI, which is confirmed to be in development, to sell at least as many copies. The opportunities to monetize this huge player base with extra content in the next installment on next-generation consoles is one reason to like Take-Two stock right now.
Grand Theft Auto is produced by Take-Two subsidiary Rockstar Games, which also created Red Dead Redemption. The 2018 release of Red Dead Redemption 2 shows the same pattern of increasing sales. The second installment of the action adventure game has sold 45 million copies to date, which is more than half the cumulative sales of the Red Dead series.
Another growing franchise is the NBA 2K series, which has sold 125 million total copies since the first version in 1999. Not every release of this annual basketball series outsells the previous installment, but the game has seen tremendous growth over the last 10 years with recent titles selling over 10 million copies each, much better than the few million that each release was selling prior to 2010.
Take-Two's expansion strategy
The company's spending on research and development (R&D) as a percentage of revenue has climbed significantly from around 7.5% to nearly 13% over the last decade. Take-Two has also made several acquisitions to expand its studio roster to bring in more game development expertise, most recently acquiring mobile game maker Zynga.
Most importantly, Take-Two has made these investments while gradually improving its operating margin and free cash flow. Over the last year, free cash flow has dropped, but that reflects greater spending on R&D to prepare for new releases.
Take-Two spends very little on extraneous items like fancy corporate office space. Instead, management plows resources into marketing and developing games, and the company's stock performance over the last 10 years shows management knows how to create long-term shareholder returns.
If the industry can grow consistent with its past record, Take-Two should grow even faster, perhaps closer to a mid-teens annualized growth rate in revenue. That could send the stock, with a current market cap of $21 billion, hurdling over $50 billion within the next five years or so.
Yes, Take-Two's track record and increased spending in R&D suggest this top video game stock is ready for a major bull run.