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Why Investing in Video Game Stocks May Be Bad in the Long Term

By Kurt Avard - Mar 10, 2014 at 1:20AM

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Ailing sales and old approaches have led to anemic action in video game companies.

Its been said many times over the last several years: video game sales are far from what they used to be. At the risk of sounding cliché, I can remember back in my childhood when a new "cutting-edge" video game cost $25. With game prices more than doubling since then alongside increasingly soaring console prices, it is no surprise that the video game market has been down. 

Still, some have been showing optimism in this somewhat lagging market. They have claimed that video games are not dead but merely in a kind of hibernation. This optimism seems misplaced, despite the recent surges in sales from games such as Grand Theft Auto V, Call of Duty: Ghosts, and similar franchise-style games.

Here's why
Console gaming requires far more of an investment on both the producer and consumer side of things. With free-to-play gaming giving much of the same interaction at a fraction of the cost and effort, why should either party invest in a game that has no guarantee of financial success?

Consoles themselves are aging. While most of these consoles have aged well compared to predecessors, the newest versions have rarely been anything bigger than a handheld device (such as Nintendo's 3DS or Sony's PS Vita.) The excitement that came with each of these handheld systems has long since run its course. While the addition of the Xbox One and the PS4 has momentarily revived excitement in classic consoles, there are still qualities of both that concern consumers.

In addition, current consoles are multi-function devices, able to access media (such as Netflix) instead of focusing strictly on video gaming. This ability has helped to maintain the existence of consoles in the household, but it may come at the cost of the gaming market itself. This is not to say that consumers will strictly buy movies instead of video games, but rather that consumers are showing tendencies to invest in lower cost movies over expensive video games. 

Fool Rick Munarriz wrote about four video game stocks to watch this past December. While two of these companies, Activision (NASDAQ: ATVI) and Take-Two Interactive Software ( TTWO 1.95% ), are priced notably higher than when that article was published, detractors note that the burst in stock prices means very little in the long run.

In the case of the former, the recent "Call of Duty" title may be the last major sales action for quite some time. Though the company just reported assets in excess of over $6.7 million, the lack of another blockbusting title makes it more than likely that assets will retreat to their quarterly average of $4.2 million, making immediate investment unattractive.

For the latter, it is likely that the recent peak sales of Grand Theft Auto V are just a continuation of historical trends (massive peaks followed by a sharp drop-off in following years). Like Activision, Take-Two assets are similarly surging for now, but average asset levels are, at best, 67% of this past quarter's level (valued at $972.1 million). 

The other two stocks mentioned in the article are somewhat harder to judge. NetEase.com is difficult because of its focus on international markets as opposed to the United States, while Microsoft is tricky because of its focus on products other than gaming. Microsoft's recent comments lend a tentative assumption that the Xbox One will continue to be a major product for the company, but not necessarily as a video game component. Instead, the rumored addition of Microsoft-generated media for the Xbox One line would indicate a departure from the market and further exploration of another media avenue.

Now what?
While this piece only focuses on two major names in the video game industry, the trends are roughly indicative of most players in the market. While some companies are potentially growing in the near future, the lack of new technical or content innovation in the video game market suggests that investment in gaming companies will not be the best option. At the very least, it's not a good bet at this time.

There are rumblings that could bode well for the future of video gaming itself, of course. Some companies are potentially exploring non-traditional gaming avenues. New platforms such as the Ouya will take the recent wave of free-to-play gaming style into account. Motion-controlled gaming is on the rise, albeit slowly, but this small innovations should not be mistaken for the next boom. 

The bottom line is that, for video game companies, things are going to get worse before they get better.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Microsoft Corporation Stock Quote
Microsoft Corporation
MSFT
$334.97 (0.01%) $0.05
NetEase, Inc. Stock Quote
NetEase, Inc.
NTES
$105.77 (-1.46%) $-1.57
Take-Two Interactive Software, Inc. Stock Quote
Take-Two Interactive Software, Inc.
TTWO
$170.55 (1.95%) $3.26

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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