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2 Videogame Stocks Worth Buying In a Bad Economy

Call of Duty Modern Warefare II.

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Courtesy Activision

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Game On. Hi everyone. I have always thought videogames deserved more respect.

Despite being the largest media and entertainment category in the world, videogames still get a fraction of the mainstream attention, compared with books, movies, music, and television shows. On Wall Street, too many investors dismiss the industry altogether as a place to find money making opportunities.

But the skeptics are off the mark. While legacy media is shrinking, gaming is the rare market that shows bright growth prospects. According to research firm Newzoo, the global gaming market is on track to grow to $211 billion by 2025 from $184 billion this year.

It is no coincidence that some of the best technology companies are betting big on videogames.
Amazon
(ticker: AMZN) and
Netflix
(NFLX) have been aggressively expanding their development capabilities.
Microsoft
(MSFT) is in the process of spending $69 billion for
Activision Blizzard
(ATVI), pending regulatory approval. If completed, it would be largest technology acquisition ever.

Most importantly, we are entering a sweet spot for the console hardware growth cycle. For two years, it was nearly impossible to buy a
Sony
PlayStation 5 and
Microsoft
Xbox Series X due to the pandemic-driven chip shortages. But now as semiconductor supplies are loosening up, production is likely to rise significantly for the next two years, providing a tailwind for game sales.

Demand is likely to remain robust especially for the PS5. Sony has said it expects to make 50% more consoles this current fiscal year, compared with the prior year. But even at higher volumes, whenever I see PS5 become available it still sells out nearly instantly.

There is also increasing evidence of pent up demand from hard core gamers for quality software releases. This is particularly true for the biggest, most expensive games, the so-called AAA titles, which are some of the most compelling and innovative forms of entertainment today, filled with moving narratives, impressive animation, and strong visuals.

Last month,
Activision Blizzard
 announced its latest Call of Duty game Modern Warfare II was the fastest-selling title in the franchise’s two decade history when the game hit $1 billion in sales during its first 10 days. Two weeks later, Sony announced that God of War Ragnarök had the bestselling opening week of any game made by one of its in-house studios

If publishers can make a quality product, consumers are willing to pay for it. Console videogames are an affordable form of entertainment, which could also temper any negative effects from a possible recession. Bernstein estimates a hard core gamer could have an implied 20 cents cost per hour with a typical AAA title, which costs $70, while a music concert or movie theater ticket comes to $33 per hour and $5 per hour, respectively. That console game can provide hundreds of hours of entertainment.

There’s one caveat to the good times for videogames. The industry is roughly split in half between console/PC games and mobile apps, and I’m less optimistic about the latter segment because smartphone players tend to be more casual and may spend less on games in a tougher economic environment. Mobile games also rely on the digital ad ecosystem to recruit players. That business model has become tougher since
Apple
(AAPL) made changes to its privacy rules for apps.

So, how should investors look at the space? I would focus on gaming companies with high quality software franchises and the ability to make the best games.

In May, I wrote that
Sony
(SONY) and
Electronic Arts
(EA) fit the bill and are best positioned to take advantage of the growth cycle for the PS5 and Xbox consoles.

Both stocks have outperformed the broader tech market since then, but their valuations remain attractive with forward price-to-earnings multiples in the mid teens along with double-digit profit growth prospects.

I’m still confident in the future for both companies.

Write to Tae Kim at tae.kim@barrons.com or find me on Twitter at @firstadopter

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Credit: marketwatch.com

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