1 Gaming Stock to Buy, 1 to Sell

Consumer spending is back. The Department of Commerce revealed this week that consumer spending was up 1% in April, the largest monthly increase in more than six years. There are a lot of things helping out the consumer these days, including rising employment and rising wages.
gaming stockWith consumer spending coming back, it’s a great time to take a closer look at ways to play the renewed interest in spending. One area in particular that’s been relatively hot of late is video games.
Now, video games aren’t just for kids anymore. The Entertainment Software Association has found that the average video gamer is 35 years old. And the gaming world is no longer dominated by males – 44% of video game players are female.
Digging deeper to see just how mainstream gaming is, the ESA also notes that more than half of U.S. households have a gaming system, and more than 40% of Americans play video games for at least three hours a week.

A Gaming Stock to Buy

Electronic Arts (NYSE: EA) released fiscal fourth-quarter earnings in May, noting that it made over $1 billion last year for the first time ever. Helping push it over the $1 billion mark was the November release of “Star Wars: Battlefront,” which piggybacked on the success of the latest release in the blockbuster movie franchise.
Of note, EA expects to grow sales by over 7% this year without launching any new “Star Wars” games. However, the real beauty of EA is its ability to capitalize on the rise of digital video game downloads. Shares are already up 10% in 2016 and are up 20% in the last 12 months.
Electronic Arts is doing well, but in truth, all the video game companies have been doing quite well recently.
EA’s top peers, Activision Blizzard (NASDAQ: ATVI) and Take-Two Interactive Software (NASDAQ: TTWO), have seen their stock prices soar by more than 40% over the last year.
Still, EA has the best balance sheet in terms of debt levels and is generating superior returns on invested capital. EA’s return on invested capital – which is income divided by debt plus equity – comes in at a hefty 26%. Activision is generating 9% returns on invested capital and Take-Two’s clocks in at 2%. As well, EA is cheaper from a valuation perspective, trading at 21 times earnings. Activision is trading at 35 times and Take-Two has lost money over the last 12 months.
Beyond all the valuation speak, EA has a stronghold in the sporting game universe, with franchises like Madden NFL and its FIFA soccer series, which help it pull in over half of all the industry’s sports video game sales. Plus, it’s already pushing heavily into online and mobile gaming.

A Gaming Stock to Sell

Meanwhile, not all video game companies are enjoying the shift toward digital. Major video game retailer GameStop (NYSE: GME) has seen its stock fall over 30% in just the last year. In fact, it’s been a tough half decade for GameStop. Its stock is up just 3% in the last five years. Meanwhile, the S&P 500 index is up 57% over the same period.
On the surface, GameStop looks like a reasonably strong company, with a solid balance sheet and a hefty 4.9% dividend yield. It’s cash flow positive and is trading at 8 times earnings; however, its attempt to diversify into digital content will only do so much for the company. It’s still very much a brick-and-mortar retailer.
Again, the issue is that instead of visiting brick-and-mortar retailers, video gamers are opting to download content. Last month, GameStop posted a 4.3% fall in sales for its fiscal first quarter, which was driven by a near 30% fall in new hardware sales. While GameStop is trying to move full steam into the digital world, it still has more than 6,000 physical stores.
If you’re looking for more of a pure-play on video games that is more leveraged to the rise of digital downloads, EA is the best bet in the industry. It’s already generating over half its sales from digital content, and it has the opportunity to engage its users beyond initial hardware and digital sales with downloadable content and multiplayer add-ons. All of which helps boost its profit margins and generate customer loyalty.

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