Like Video Game Stocks? 2 Hot Buys for February

Until recently, shareholders of Activision Blizzard (NASDAQ: ATVI) and Take-Two Interactive (NASDAQ: TTWO) have had plenty of reason to be happy with their investments. But some holiday season sales setbacks have caused each stock to get hit by substantial sell-offs. The stock prices have cooled off, but that's also made them more approachable and raised the potential payoff for long-term investors.

Last year, the global video game market generated roughly $138 billion in revenue, up from roughly $76.5 billion in 2013. Research firm Newzoo estimates that the industry's gross revenue will hit $180.2 billion in 2021. That's an encouraging backdrop, and it suggests that leaders in the video game space have opportunities to drive and capture industry growth and deliver strong performance for shareholders.

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Don’t count this game company out

Activision Blizzard shareholders have had to endure a few months of disappointing news and stock performance. The tough stretch kicked off early in November, when the company took the wraps off Diablo Immortal — the first mobile installment in the long-running franchise and one that hardcore fans seemed to have little appetite for. The significance of the botched game unveiling seemed to be magnified when the company reported third-quarter results roughly a week later and delivered slipping sales and earnings.

More recently, the company announced that it is dissolving its relationship with Bungie, and that it would no longer play a role in supporting the developer's Destiny franchise. Add in some volatility for the broader market, and there's a pretty clear narrative explaining why the stock is down roughly 35% over the last year. However, counting Activision Blizzard out would be a mistake.

Activision Blizzard stock has still posted very strong performance over the last five years, and the core components of a bullish long-term thesis remain intact. It's undeniable that some of the company's big franchises are losing steam and that there have been some execution issues that have left investors dissatisfied, but Activision Blizzard still enjoys a commanding position in an industry that has a long runway for growth.

The video game industry has become less cyclical as it has shifted away from one-time software sales and toward recurring-revenue models, but the waxing and waning cycle of big franchises still has a big impact on publishers' performances. It seems like the market has taken the recent slowdown as an indication that Activision Blizzard's growth trajectory has been derailed. But the company has underappreciated opportunities as it continues its push into mobile, launches new franchises, expands in international markets, and explores still-nascent businesses like esports and augmented-reality and virtual-reality content. The gaming industry is only going to get bigger, and Activision Blizzard remains a top play in the space for long-term investors. Shares trade at roughly 17 times this year's expected earnings.


Take this post-earnings opportunity to buy Take-Two

To use some video game language, publisher Take-Two Interactive has "leveled up" a lot over the last nine years — jumping from small cap, to mid cap, to large cap in less than a decade. A rapid run-up like that can be cause for skepticism or caution. But it looks like Take-Two will continue to deliver wins for long-term shareholders, and a recent post-earnings stock slide presents a worthwhile entry point.

Take-Two stock hit a lifetime high in September thanks to fantastic ongoing performance from Grand Theft Auto V and excitement surrounding the release of Red Dead Redemption 2. However, the stock lost ground along with other video game stocks and the broader market as 2018 progressed, and it posted steep declines this month following the publication of the company's third-quarter results.

Take-Two's sales and earnings performance came in well above the market's expectations, and the company actually raised its full-year targets. Red Dead Redemption 2 has proven to be a huge hit and crushed expectations, shipping over 23 million copies and remaining in a good position to continue to posting strong unit sales and high-margin revenue from online microtransactions. However, Take-Two's stock appears to have been negatively affected by the perceived threat posed by Epic Games' hugely popular Fortnite and disappointing earnings and guidance from industry rival Electronic Arts.

Some investors and analysts seem to be approaching the Fortnite sensation as though it came completely out of left field. The story of how the game went from flop to phenomena is certainly an interesting one, but a narrative seems to have emerged that the game came from an inexperienced developer — and that the barriers to entry for the triple-A gaming market have now been dramatically lowered. The truth is that Epic Games is actually responsible for hugely successful and influential franchises like Unreal and Gears of War — not exactly the plucky upstart that some industry watchers imagine, and the long-term impact of Fortnite is more likely to be a widening of the total game-playing audience than the downfall of publishers like Take-Two.

While it has to compete with other companies for players' time and spending, the market seems to be misreading the Fortnite situation, and Take-Two's business has never looked stronger. Its core Grand Theft Auto, Red Dead Redemption, and NBA 2K franchises are in great shape, and the company is expected to launch another big triple-A title before the end of its next fiscal year. Like Activision Blizzard, Take-Two should also benefit from increasing its presence on mobile platforms, a growing global audience for games, and the rise of esports. Shares look worthwhile trading at 19 times this year's expected earnings.

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Keith Noonan owns shares of Activision Blizzard and Take-Two Interactive. The Motley Fool owns shares of and recommends Activision Blizzard and Take-Two Interactive. The Motley Fool recommends Electronic Arts. The Motley Fool has a disclosure policy.

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