Solid Growth Pick in a Growing Industry

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

PC sales are dipping, with desktop processor sales on the decline. One can say that the market for PC based casual games is shrinking, owing to the rapid growth of smartphones, tablets and ultra-books. But gamers looking to enjoy high graphical gameplay still opt for high performance laptops, desktop PCs and consoles like Xbox and PlayStation. This is exactly where game developers Activision Blizzard and Electronic Arts roll in. However it cannot be denied that the falling number of PC users negatively impacts PC based game developers.

So what can be done?

In game development, constant innovation and improvisation is required. One cannot be stagnant, otherwise gamers get bored which leads to a loss of market share. Shares of Zynga (NASDAQ: ZNGA) are down by more than 80% YTD for the same reason. I believe that overdoing “-ville” games lead to its decline. Though the company reported 151 million “Monthly Unique Users,” only 2.9 million users coughed up money for “In-Game” purchases.  However, Zynga tried to diversify by bidding for Rovio, but the latter declined Zynga’s offer. Shares of Zynga trade at forward P/E of 238x, and the company has a negative net profit margin of 46.51%. In short, I don’t think Zynga has any upside to offer.

Electronic Arts (NASDAQ: EA) also misses out on the fundamentals. It’s shares carry a ridiculously high P/E of 1491x with a PEG of 99.07x indicating that EA is hugely overprice compared to its earnings and growth potential. Also its meagre net profit margin of 0.37% and ROE of 0.64% highlights an incompetent management. Though the company has released some popular games, EA looks weak fundamentally, and this negates any kind of strength in its topline.

Activision Blizzard (NASDAQ: ATVI) however looks attractive. Its share trade at a forward P/E of 11.22x and its P/FCF equates to a healthy 10.77x. The company operates with little or no debt, and with a quick ratio of 3.02x, ATVI wouldn’t have any problems with unplanned short term liabilities. The company enjoys a net profit margin of 19.89% and its shares yield a decent 1.625 with a modest payout ratio of 23.3%.

Activision Blizzard is known for its “Call of Duty” series, which is one of the fastest selling entertainment franchises in the world. The company recently released its latest edition of Call of Duty, which reached $1 billion in sales, in just 15 days. Analysts estimate the sales momentum to continue, which means ATVI could have a solid quarter ahead. However its share price has been sliding, owing to concerns regarding a slowdown in the industry. The fact that “Call of Duty” reported record sales only indicates that the gaming industry is very much alive, and the fears were unwarranted.

This is one of the reasons behind ATVI’s low P/E. On the back of record sales and an impressive net profit margin, it would be safe to expect higher earnings in its next quarter. This means that if ATVI will be fairly valued (P/E wise), it share price needs to appreciate significantly. In my opinion, ATVI’s falling share price gives investors a solid opportunity to initiate long positions while it’s still available at lower valuations.

 
 


PiyushArora has no positions in the stocks mentioned above. The Motley Fool owns shares of Activision Blizzard. Motley Fool newsletter services recommend Activision Blizzard. 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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