Why Investors Won't Make Money On Next-Gen Video Games

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Video games are a billion-dollar business by sales, but they are a bust for investors. As the console wars heat up, we'll look at why video game companies are the worst way to play rising consumer discretionary purchases.

The business of gaming

The video game console industry is built on the idea of “platforms,” much like more modern smartphone and tablet makers. The idea is simple: video game companies subsidize the sale of console hardware in order to grab gamer marketshare. From there, licensing and game sales are expected to generate the profits.

Betting on gaming is difficult, as there are no true pure-plays in the space. Here's a quick background on videogame stocks and why they're uninvestible:

Nintendo (NASDAQOTH: NTDOY.PK) – Nintendo led the next generation of console wars with its new Wii U console release, which beat rivals to be first to launch. What plagues Nintendo isn't the device or the market reception, but rather the financial mismanagement at Nintendo.

The company has net cash of $11 per American ADR. The balance, literally about $800 million of market cap, is attributed to a combination of Nintendo's vast video game franchises and the partial ownership of the Seattle Mariners. Despite carrying no debt, Nintendo has no plans to pay a dividend or repurchase shares, which makes Nintendo just one massive value trap, regardless of the Wii U's performance.

Sony (NYSE: SNE) – This down and out electronics company used to lead where it mattered. Sony was the company that was known as the innovator for big products like the smallest transistor radio and a record-selling Sony Walkman.

Sony's foray into video games has been marked with losses, however. The company lost a combined 415 billion yen in video games from 2006 to 2008, only to turn a tiny 47 billion yen profit in 2010. The “One Sony” plan has yet to turn around the video game segment, which can hardly sustain another subsidized generation of consoles. Sony's silence on its future video game plans – with the exception of a launch with zero new details – should steer investors clear.

Microsoft (NASDAQ: MSFT) – Microsoft's bread and butter are the operating systems and Office Suite, which provide the company with virtually all of its operating profits. The Xbox division provides virtually little upside for this behmoth. Investors would likely gain more from attacking its $68 billion in cash and short-term investments, which should be paid out to investors as part of larger dividend or share repurchase plan.

No way to play

There simply isn't a good way to play the next batch of video game launches. Nintendo is unwilling to part with any of its retained earnings for shareholder friendly moves. Sony has yet to provide enough information about its PS4 system – and history suggests it is much better at losing money than making money on consoles. Finally, Microsoft's Xbox profits are merely a drop in the bucket compared to its profits from operating systems and the Office Suite.

If you want exposure to video games, buy the systems. There's just no investment to be made here in any form.  

valuemagnet has no position in any stocks mentioned. The Motley Fool owns shares of 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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