How to Play the Video Game Market

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

If you are interested in getting exposed to consumer goods, make sure you hunt out the undervalued stocks and don't overly "diversify" into junk stocks. Sadly, there are quite a few that fall into the latter category in video games. However, if you can eye either the turnaround plays or the ones creating sustainable and large economic moats, you are on your way to massive returns...

Activision Blizzard (NASDAQ: ATVI): Buying Stock in Video Games

When it comes to "cool" stocks, Activision always tops my list. It is led by top management and, besides, who wouldn't want to make money on video games? At a respective 15.8x and 10.5x past and forward earnings, you can also get in this "cool" stock at relatively cheap prices. Fortunately, the value ahead looks bright with forecasts for 10.9% annual EPS growth over the next five years.

Operationally, Activision has performed well. All of the last five quarters have produced results significantly above expectations. Yet, strangely enough, the company has lost 13.5% in value over the last 12 months. I encourage buying in anticipation of a market correction. While the market was weak with game console sales falling 39% y-o-y in September, Activision has done a strong job in building sustainable streams of free cash flow to offset churn from World of Warcraft. These streams are coming from top title launches, like Call of Duty, Skylanders, Starcraft.

In fact, in the second quarter, Activision's EPS of $0.18 came in solidly ahead of forecasts - so much that management boosted guidance for this year. With roughly two million subscribers for Call of Duty, the company has plenty of room for greater penetration and cross-selling. The company's successful brand name has been successfully leveraged to help make up for old cash cows. For example, after Guitar Hero died down, Activision released Skylanders, which represented the biggest individual percentage of business in 1H12. Expansion packs have meanwhile kept revenue flowing in.

Electronic Arts (NASDAQ: EA) & THQ (NASDAQOTH: THQIQ): A "Staying Alive" Story

In contrast to Activision, EA is really struggling. Over the last 12 months, the company has lost nearly half of its value; but, for good reason. Earnings have been under expectations by an average of 10.3% in the last two quarters before 1Q13. Gaming Blend recently wrote a funny article highlighting how many disastrous titles the company has made: FIFA 13, NHL 12, NHL 13, and so on, and so on. As the website smartly humored: "And what about FIFA 13 for Wii? Oh yeah, you didn't think we forgot about that right? ... You're literally paying full price for FIFA 12 just with a logo change!" Things are so bad that The Consumerist recently ranked EA "The Worst Company in America."

Even Star Wars: The Old Republic, which was expected to be a tremendous hit, yielded disappointing results. Packaged goods also cut into what would have otherwise been a mediocre turnaround. The company, however, is trying to pitch its future in online & mobile gaming. But this will come under increasing pressure from independent producers in the smartphone and table app market.

If there is one stock to consider buying that's struggling, it is THQ. It has lost nearly 62% in value for the year to date and is a possible target for asset sales. While no suitor would jump in and acquire the business outright, there are connections to the major consoles and handheld devices, including the iPhone and iPad, that would be worth capitalizing on. Unfortunately, weak momentum in titles has led this foundation to overshadow this otherwise credible foundation.

TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Activision Blizzard. Motley Fool newsletter services recommend Activision Blizzard and Electronic Arts. 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.If you have questions about this post or the Fool’s blog network, click here for information.

blog comments powered by Disqus