The fourth-quarter earnings season is in full swing. That means companies from all over the world are updating investors on their latest financial numbers, which is what you need to pay attention to most if you own individual equities. One company I have been following closely for many years is the Japanese entertainment giant Nintendo (NTDOY -2.04%).
The maker of the popular Switch video game console just posted its earnings for the last three months of 2022. Forward guidance disappointed the investing community, causing the stock to slip by around 10% in the following days. The shares are down 20% over the last 12 months, underperforming the broad S&P 500 index over that same time period.
Nintendo stock keeps slipping to lower levels. Let's see whether this drop was warranted or if now is a perfect time to buy some shares.
Q3 earnings: Forward indicators weakening
Nintendo fiscal 2023 ends this March. The company's earnings looked fairly solid through the first nine months. Operating profit was $3 billion, down around 13% from the same period in 2021. A slight decline in profitability is not a huge deal considering that the Switch is coming out of its peak sales period. That is just how the gaming industry works -- earnings cyclicality is a feature, not a bug, especially for companies that sell gaming hardware like Nintendo.
Profits were driven by record game launches for the Splatoon and Pokémon franchises. Since its launch on Sept. 9, Splatoon 3 has sold over 10 million copies, while Pokémon Scarlet & Violet has sold 20.6 million copies since its release in late November 2022. These popular games, along with continued sales from smaller titles (27 games have sold over 1 million copies so far this fiscal year), are why Nintendo's profits have held up compared to a year ago.
However, Nintendo lowered its guidance for the full fiscal year that ends in March, which is something investors -- especially ones on Wall Street -- greatly dislike. Guidance for Switch hardware sales went from 19 million to 18 million, with software sales guidance going from 210 million to 205 million. These are just small changes, but with management talking on its latest conference call about weakening demand compared to last holiday season, investors are likely nervous about what hardware and game sales will look like over the next few quarters.
Don't play the quarterly game; the stock is still cheap
I too think the next few quarters could be tough for Nintendo. The Switch is heading into its sixth year since release, which typically marks the end of the road for a gaming console. But with no signs from Nintendo management that a successor to the Switch is coming out soon, this gaming business could go through a cyclical trough in calendar year 2023.
As a shareholder of Nintendo, this does not concern me one bit, because I know that Nintendo always plays the long game with its business strategy. In fact, there are multiple initiatives the company has done or is working on that I believe will smooth out earnings and lead to higher annual earnings for Nintendo this decade, even if 2023 is not a record year. At a current price-to-earnings (P/E) ratio of just 13.5, the stock looks very cheap if this turns out to be true.
NTDOY PE Ratio data by YCharts
Why future earnings will be more stable
Historically, when Nintendo released a new piece of gaming hardware, it wouldn't port over any games from its old consoles, meaning it had to kick-start demand from scratch by trying to attract new users with new game launches. It also had zero (or in some cases, very poor) online playing capabilities, putting it behind the eight ball with competitors like Xbox and PlayStation. This made Nintendo's earnings much more cyclical when it transitioned from one gaming hardware to the next.
This has changed. With the launch of the Switch, Nintendo started offering Nintendo Switch Online (NSO) subscriptions to users who wanted to play with people around the world. As a part of these subscription tiers, the company has started to offer access to Nintendo games from previous consoles and additional add-on content for its popular Switch games like Animal Crossing and Mario Kart 8. NSO subscriptions have grown every year since launch and are now at least 36 million (the last update was in early November 2022).
Nintendo is also finally expanding outside of just video games with its entertainment franchises. It has multiple theme parks going up around the world in a partnership with Universal Studios. Plus, The Super Mario Bros. Movie is coming out in theaters this spring. While these won't generate billions in profits each year like the Nintendo gaming business, they can help diversify Nintendo and make it a more Disney-like entertainment giant by the end of this decade.
With more recurring revenue, the expansion outside of video games, and the addition of legacy titles, I think Nintendo's future earnings will be much more stable as it moves from one console to the next. At its current price, the stock looks like a buy for people aiming to hold for many years.
