When the markets fall, the entertainment industry is a promising area to look for undervalued stocks. No matter what happens to the economy in the near term, demand for entertainment will create new moneymaking opportunities for industry leaders, driving their value to investors higher over the long term.
Investors have several choices in this industry, but I would strongly consider Activision Blizzard (ATVI) and Walt Disney (DIS -0.45%). Let's look at key catalysts that could send these two stocks higher over the next few years.
1. Activision Blizzard
Shares of this leading video game producer trade at a significant discount to Microsoft's buyout offer of $95 per share. Microsoft originally announced plans to acquire Activision in January of 2022 in an all-cash deal. At the current price of around $80, Activision stock could return 19% to investors upon the closing of the deal, but uncertainty over the outcome of the regulatory approval process has weighed on Activision's share price.
Regardless of whether the deal is completed or not, investors are getting Activision's leading intellectual property at a discount, as noted by Microsoft's $68 billion offer for the entire company.
The World of Warcraft owner reported outstanding financial results in the fourth quarter. Strong sales of the company's latest installment in the Call of Duty franchise drove a robust 43% year-over-year increase in bookings -- a non-GAAP (adjusted) measure of revenue. More content releases from Diablo and Overwatch should lift Activision out of its five-year slump, where a lack of new game releases weighed on revenue growth.
ATVI Revenue (TTM) data by YCharts.
The reasons Microsoft wants to acquire Activision are the very reasons investors should consider the stock. The combination would provide the software giant with a valuable roster of top games to attract more subscribers to the Xbox Game Pass service. Activision stock is up 11% since its fourth-quarter earnings report in early February, and given the strong performance from Call of Duty, the shares could head higher regardless of what happens with Microsoft.
Activision currently trades at a price-to-earnings ratio of 21 times 2023 earnings estimates, which is a fair price ahead of opportunities to reach a wider audience with its investments in mobile games and other initiatives to double down on its top franchises. Wall Street analysts expect earnings per share to grow at an annualized rate of about 12% over the next five years.
2. Walt Disney
Shares of Disney have fallen 34% through the market downturn, but the market is undervaluing the House of Mouse for a few reasons.
The return of Bob Iger, who previously led Disney to market-beating performance from 2006 through 2019, is a major near-term catalyst that the market is not fully appreciating. Wall Street is mostly concerned about the near-term headwinds in the economy pressuring advertising revenue at Disney's media networks (ABC and ESPN), in addition to Disney's money-losing streaming business. But one of Iger's top priorities is to keep Disney+ on track to turn a profit by fiscal 2024.
Meanwhile, there are plenty of opportunities for Disney to impress investors with solid financial results this year. The Mandalorian just returned to Disney+ for season three after a two-year absence, which is a catalyst for subscriber growth. Disney also has a great slate of films coming to theaters this year, including The Little Mermaid, Pixar's Elemental, Indiana Jones and the Dial of Destiny, and Disney's Haunted Mansion.
Another thumbs-up goes to Disney's theme park recovery, which has been impressive. The parks, experiences, and products segment has already surpassed pre-pandemic levels of revenue and operating profit. Iger indicated they are prepared to capitalize on this momentum with plans to launch a new Avatar-themed attraction at Disneyland.
Moreover, Disney's current share price is not counting any additional value that might be created under Iger's watch, including reinstituting the dividend and selling or spinning off assets (e.g., media networks and/or the Hulu streaming service). This would free up capital to pay down debt, raise the dividend, and double down on Disney's core entertainment properties.
Overall, Disney is trading at the same price level as it was four years ago, while analysts expect earnings to grow at an annualized rate of 20% per year over the next five years.
