Video game companies saw their businesses overwhelmed by the COVID-19 pandemic lockdowns. With many people stuck indoors, money that could have been spent on travel or experiences was spent on home entertainment like TV, movies, and console games in 2020 and 2021.
Now, with the pandemic in the rearview mirror, investors are turning bearish that gaming industry sales will fall 1.2% in 2022, causing many video game stocks to decline in value. If you are a long-term investor, these price declines can be buying opportunities for companies with multiple long-term tailwinds.
Here’s why now is an opportune time to buy video game stocks.
The end of console supply chain woes
One of the main ways that people play video games is through dedicated console hardware. At the end of 2020, Microsoft (MSFT -1.27%) Y Sony (SONY -1.37%) — two of the top three console makers — released next-gen hardware to consumers, the most significant upgrade for the industry since the last console cycle in 2013. While demand for games was red hot right now , the timing of the launch could not have been worse due to the growing shortage of semiconductors around the world.
Game consoles are essentially just computers optimized for playing video games, requiring high-end computer chips and semiconductor equipment to function properly. With semiconductor supplies running low, both Xbox and Playstation have been unable to make enough console supplies to meet consumer demand. Today, almost two years later, it is still extremely difficult to buy a new Xbox or PlayStation console. Without the new hardware, consumers are likely to delay purchases of new console games, which will reduce sales in the short term.
It’s unclear exactly when the semiconductor shortage will completely end. But when it does, it should accelerate game sales across the industry as more than 100 million people worldwide get new Xbox and Playstation hardware. For companies with large portions of their revenue coming from console games, this will be especially beneficial and should be an easy tailwind to manage over the next three to five years.
Cloud gaming will be a game changer
But what if gamers didn’t need to buy a $500 console to play next-gen games? That day may be closer than we think with the investments companies like Xbox are making in cloud gaming.
What is cloud gaming? It is the ability to have all the computer processing necessary to play a game made on an external server connected through the Internet instead of dedicated gaming hardware. Xbox/Microsoft is experimenting with cloud gaming through its Game Pass subscription service. Investors should expect other companies like Sony to invest in cloud gaming technology because once it goes mainstream, it should drive more gamers to play video games at the console level. Why? Because if you remove the barrier to entry of needing to spend $300-$500+ just to have the ability to play popular games, chances are more and more casual gamers will start playing them in their spare time.
Outside analysts are optimistic about the growth of the cloud gaming market in this decade. By 2029, the market is expected to reach $41 billion in annual spend and grow at a compound annual growth rate (CAGR) of 43% from now to then. Those are phenomenal growth numbers and a lot of new revenue for game companies to capture this decade.
So what are the best gaming actions?
The video game industry is clearly in a good place, even though the market is set to plateau in 2022. Two high-quality stocks that will specifically benefit from the end of the console shortage and cloud gaming are electronic arts (EA -1.52%) Y Interactive Take-Two (TWO TWO -3.82%). Both are game publishers with great exposure to the console market and have great franchises that have stood the test of time.
For EA, it has sports titles like fifa Y crazy nfl along with other games like apex legends Y the Sims with huge fan bases all over the world. Take-Two owns the incredibly popular publisher, Rockstar Games, which created Grand Theft Auto, red dead redemption Take-Two also owns NBA 2Kwhich, like EA titles, have huge, dedicated customers who have spent time with the franchises for many years.
EA has a P/E of 38 and Take-Two has a P/E of 80. Both seem expensive, but given the weird accounting tricks of game revenue recognition and irregular sales for game publishers, stay behind. P/E ratios are not the correct metric to look at when evaluating these stocks. It is about the portfolio of games and the future cash flows that these businesses will generate.
For EA it has cash cows with its sports game franchises it is ready to add back its popular NCAA football game next year, and has over a dozen different non-sports titles in the works. Take-Two is ready to launch the next title in its Grand Theft Auto game sometime within the next few years. Your previous title — Grand Theft Auto V — is the best-selling single game in history. Add in the proliferation of cloud gaming, and I think both EA and Take-Two are poised to massively increase their cash flows over the next 10+ years. Regardless of what P/E the stock is trading at, that makes both companies buy at this point.
Brett Schafer has positions at Electronic Arts, Nintendo, and Take-Two Interactive. The Motley Fool has positions and recommends Microsoft and Take-Two Interactive. The Motley Fool recommends Electronic Arts and Nintendo and recommends the following options: $115 January 2023 Long Calls at Take-Two Interactive. The Motley Fool has a disclosure policy.