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Not Without Nintendo

Kyle is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

As petty as it may sound, video games were a huge part of my childhood and adolescence. The time I spent gaming was an example of how consoles dominated the market throughout the majority of the last twenty years. Reminiscing while researching investments lead to me stumble upon GameStop (NYSE: GME). When I pulled up the Morningstar page I almost laughed: "GameStop holds approximately 80% of the used video game retail market." With no intention on knocking bargain buyers, do people still buy used games? Everyone I know uses apps on at least one device, and these always come "new."  GameStop has been successful with their venture, but the hungry market drove their profits.

Going back to my title, the driving force for this industry is (and will continue to be) Nintendo (NASDAQOTH: NTDOY). Third party developers have been developing (and milking dry) excellent franchises that drive game sales, but more consumers have at least one Nintendo console in their house than any of its competitors. The new WiiU sold 400,000 consoles in its first week on the market. Instead of focusing on advanced graphics and performance, Nintendo stays ahead on innovative gameplay, creative console function, and their collection of legendary icons that have withstood the test of time. The company is the leader in luring "non-gamers" and families to purchase new systems and stick with the brand for life.

Nintendo's shares have tumbled over the last year, but the company is in the green concerning free cash flow and net income. This will allow the company to continue to innovate in its collection of homemade games, which allow Nintendo to collect more profit because most of their game successes do not go through third-party developers. The absence of a dividend in 2012 may seem disconcerting, but as long as there is a console market, Nintendo will pump out the profits.

GameStop is famous for having "launch parties," or events hosted prior to the release of a highly anticipated game. These are fun for customers and help promote new titles, but it’s merely an effort to cling onto customer loyalty in the shadow of retailers such as Amazon and Wal-Mart. Unlike others, GameStop operates as pure video game retailer. This concept is completely dependent on the developers, and without their continued success, net income may tumble back into the red.

Concerning developers, Nintendo is the best bet. Sony (NYSE: SNE) has essentially been a mess since the glory days of the PlayStation 2 ended nearly six years ago, at least as far as its console gaming department. The company hasn't turned over a profit in any of the past three years and has a dramatically dwindling free cash flow. Things don't look good financially, which could translate into lesser investments into new gaming innovations. Sony cannot depend on Call of Duty forever.

Perhaps the bigger fear for GameStop should be that Sony and Microsoft (NASDAQ: MSFT) are competing with next-generation systems on the playing fields of graphics and performance. Nintendo's Wii and WiiU are both behind the current PlayStation and Xbox models in these categories, and Microsoft's XBox 360 has outsold both the Wii and WiiU combined in 2012. Sony and Microsoft have been able to keep their systems selling through successes such as Call of Duty, Halo, and Assassin's Creed. Excellent games have been produced, but there is less focus on innovation and therefore less motivation for consumers to purchase an older console only a few months before Sony and Microsoft are releasing their next-gen models.

GameStop is exclusively a video game retailer, and Nintendo is exclusively a video game developer. Sony and Microsoft will be in this market for a long time, but these companies have other profitable ventures. Nintendo needs to lead the pack of the industry to keep GameStop afloat. With the holiday season closing, look for sales numbers for Nintendo as in indicator for market hunger. Unless something spectacular shows up, it will prove wise to give Mario and company a bit more time to help GameStop.

KyleVaughan has no positions in the stocks mentioned above. The Motley Fool owns shares of GameStop and Microsoft and is short Sony (ADR) and has the following options: long JAN 2013 $22.00 calls on Sony (ADR). Motley Fool newsletter services recommend GameStop and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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