Video games have steadily grown in popularity over the last few decades. In fact, the industry is now one of the largest entertainment categories worldwide, with estimated global annual spending of just under $200 billion in 2022.
But the party is just getting started. Analysts expect the video game market to reach close to $300 billion by 2027 as the industry matures into older populations.
From an investment perspective, this steady industry growth makes the video game market a great place to hunt for new stocks to buy. Here's why Electronic Arts (EA -0.19%) -- one of the world's leading game publishers -- is a no-brainer buy for investors as we head into 2023.
Dominance in sports
Most people know EA for its longtime success with sports video games. This comes from a multitude of franchises, the most important being FIFA Soccer and Madden NFL. Both games have near-monopolies in their respective sports simulation categories. EA has an exclusive deal for Madden with the NFL for football simulation titles through 2026, while it has signed dozens of licensing deals with different soccer leagues and organizations around the world for FIFA Soccer.
The soccer title now has virtually zero competition from other game publishers and has been able to easily ride the growth of the video game market. Last quarter, EA informed investors that its latest game had grown unit sales by 10% from the previous year's title, which will translate directly to revenue growth.
Investors should expect these sports titles to increase players and revenue this decade along with the broader video game market. But there is one popular sports title making a comeback that can be the third pillar in EA's sports strategy: NCAA College Football. The title used to have a rabid fan base but was canceled in 2014 due to complications around paying players. Now that it's officially legal to pay college athletes, EA has announced the franchise will be making a comeback in 2024. We know few details about the game right now, but I think it can help drive growth for EA over the next three to five years.
Diversification across nonsports titles
Historically, EA has relied mainly on sports titles to grow its business. But over the last five years, it has diversified into non-sports titles with a lot of success. These include the popular Apex Legends franchise, which launched in 2019 and is now one of the top live services games (games that make money through online multiplayer and add-on purchases) worldwide. The title does more than $1 billion in net bookings (the equivalent of revenue for video games) annually, which is a large percentage of EA's consolidated net bookings of $7.4 billion.
EA has a huge slate of games coming to market over the next few years. One that investors should watch for is Star Wars Jedi: Survivor, coming in early 2023. The game is a sequel to the popular Star Wars Jedi: Fallen Order, which sold over 10 million units within a year of its launch. EA has multiple Star Wars games, an Iron Man game, and tons of mobile titles coming to market over the next few years.
Some of these -- like the recent Battlefield title -- will end up being flops. But by getting a lot of shots on goal, the publisher should be able to grow revenue from its non-sports games over the next few years.
But what about the valuation?
Because of certain accounting rules surrounding revenue recognition for gaming companies, net income is a misleading metric for valuing the profitability of EA. The best metric to use is operating cash flow. Over the last 12 months, EA has generated $1.79 billion in operating cash flow, giving it a price-to-operating-cash-flow ratio of 18.8 based on the stock's current market cap of $33.6 billion.
But EA's trailing operating cash flow is actually understating its future earnings potential. When the company accelerates its games development pipeline (as it is doing right now), it has to spend a bunch of money up front, depressing earnings until the games come to market. Over the next two to three years, once these games are released, investors should expect EA's operating cash flow to move higher.
From my seat, that makes EA stock very cheap right now and an easy buy at these prices.
