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Can These Three Online Gaming Stocks Develop In The Fourth Quarter?

The fourth quarter for gaming stocks is typically a busy one, with most major game titles released in the period between September and December to catch the Christmas rush. These three firms own large titles such as FIFA, Sims, Madden, Battlefield, Grand Theft Auto, NBA 2K, Red Dead Redemption, FarmVille and Words With Friends. With the release of next-generation gaming consoles, game prices for AAA titles (those given the company’s largest budget) have risen to $70, increasing product value from sales.

In recent news, the Chinese government has regulated gaming for minors, imposing a limit of an hour of play time between 8:00 p.m. and 9:00 p.m. on Fridays, weekends and public holidays. These restrictions were being issued for the return to school, in an attempt to prevent addiction to online games. Also, the decision was made to temporarily suspend approval for all new online video games. China’s previous policy for minors’ play time was 90 minutes on weekdays and three hours on weekends for children.

On a positive note, Epic Games recently won its lawsuit against Apple (AAPL), in which federal judges said Apple cannot force developers to use its in-app purchase system. This was a critical point to overcome, limiting sales for many mobile developers. This pullback will allow companies such as Zynga to increase revenues and reduce cost of goods.

Video game sales rose in August 2021, a sign of sector strength as it’s the fourth consecutive month of year-over-year gains against tough comparisons from 2020 when gaming skyrocketed during the coronavirus pandemic. According to market research company NPD Group, overall industry sales rose 7% compared to August 2020, to reach an August record of $4.4 billion. Year-to-date video game industry spending is $37.9 billion, up 13% from the same period last year.

Grading Gaming Stocks With AAII’s A+ Stock Grades

When analyzing a company, it is useful to have an objective framework that allows you to compare companies in the same way. This is one reason why AAII created the A+ Stock Grades, which evaluate companies across five factors that have been shown to identify market-beating stocks in the long run: value, growth, momentum, earnings estimate revisions (and surprises) and quality.

Using AAII’s A+ Stock Grades, the following table summarizes the attractiveness of three gaming stocks—Electronic Arts, Take-Two Interactive Software and Zynga—based on their fundamentals.

AAII’s A+ Stock Grade Summary for Three Gaming Stocks

What the A+ Stock Grades Reveal

Electronic Arts (EA) is one of the world’s largest third-party video game publishers and has transitioned from a console-based video game publisher to the one of the largest publishers on consoles, PC and mobile. The firm owns a number of large franchises, including Madden, FIFA, Battlefield, Apex Legends, Mass Effect, Dragon Age and Need for Speed. The company will consolidate its leading position by developing compelling new versions of its existing franchises, creating new ones like Apex Legends, and acquiring established ones like F1 from Codemasters.

Analysts expect Electronic Arts to continue to benefit from the upcoming new generation of consoles, the ongoing revitalization of PC gaming and the growth in the mobile gaming space. Electronic Arts announced Battlefield 2042 during the most recent quarter, which is the latest installment in the firm’s crown jewel shooter video game, to be released on October 22. The game is the only non-annualized AAA title currently scheduled to be released in fiscal 2022. While the last installment, Battlefield V, was a slight commercial disappointment, analysts expect a rebound given the more modern setting and the positive reaction to the trailer.

EA is focused on engaging users beyond the initial game sale, extending the monetization window by expanding the use of multiplayer options and releasing downloadable content or DLC. Online multiplayer games or game modes lead users to develop social networks, thus encouraging player loyalty via either informal friendship networks or actual teams/clans. DLC can either refresh the multiplayer experience by introducing new maps and increasing the level caps or prolong single-player engagement by extending the storyline. DLC for the FIFA and Madden games accounts for over 70% of revenue.

Earnings estimate revisions offer an indication of what analysts are thinking about the short-term prospects of a firm. The company has an Earnings Estimate Revisions Grade of B, which is considered positive. The grade is based on the statistical significance of its last two quarterly earnings surprises and the percentage change in its consensus estimate for the current fiscal year over the past month and past three months.

Electronic Arts reported positive earnings surprises in the prior two quarters. Over the last month, the consensus earnings estimate for the third quarter has increased from $1.125 to $1.148 per share based on three revisions: two upward revisions and one downward. Three months ago, the consensus earnings estimate was $1.092 per share.

A higher-quality stock possesses traits associated with upside potential and reduced downside risk. Backtesting of the quality grade shows that stocks with higher quality grades, on average, outperformed stocks with lower grades over the period from 1998 through 2019.

Electronic Arts has a Quality Grade of A. The A+ Quality Grade is the percentile rank of the average of the percentile ranks of return on assets (ROA), return on invested capital (ROIC), gross profit to assets, buyback yield, change in total liabilities to assets, accruals to assets, Z double prime bankruptcy risk (Z) score and F-Score. The score is variable, meaning it can consider all eight measures or, should any of the eight measures not be valid, the valid remaining measures. To be assigned a quality score, though, stocks must have a valid (non-null) measure and corresponding ranking for at least four of the eight quality measures.

The company ranks highly in terms of its return on assets and buyback yield, ranking in the 75th and 86th percentile of all U.S.-listed stocks, respectively. However, it ranks poorly in terms of its accruals to assets, putting it in the 57th percentile.

Electronic Arts has a Momentum Grade of D, based on its Momentum Score of 34, and a weak Growth Grade of D. Electronic Arts has a 0.5% dividend yield.

Take-Two Interactive Software (TTWO) consists of two wholly owned labels, Rockstar Games and 2K. The firm is one of the world’s largest independent video game publishers on consoles, PCs, smartphones and tablets. Take-Two Interactive’s franchise portfolio is headlined by Grand Theft Auto (345 million units sold) and contains other well-known titles such as NBA 2K, Civilization, Borderlands, Bioshock and XCOM. The firm is well-positioned not only to capitalize on the success of Grand Theft Auto, but also to continue diversifying its revenue beyond its signature franchise.

Similar to Electronic Arts, Take-Two will benefit from demand for new consoles, revitalization of PC gaming and the growth of mobile gaming. Its largest annual franchise, NBA 2K, is the most popular sports game in both the U.S. and China. In addition, Take-Two Interactive introduced a separate multiplayer mode, GTA Online, with the launch of Grand Theft Auto V in 2013. The mode has helped this installment sell over 145 million units by expanding its life cycle and monetization. As a result, Grand Theft Auto V will be launched on its third generation of consoles in November 2021, pushing the potential launch of Grand Theft Auto VI even further out.

Beyond digital downloads, the microtransactions in both GTA Online and NBA 2K help extend the economic returns from a title while providing high-margin revenue and increasing customer engagement. Rockstar originally released Grand Theft Auto V in September 2013, but it continues to sell well. Grand Theft Auto V’s total lifetime sales exceeded 75 million copies by February 2017 and 85 million copies by November 2017. In comparison, Grand Theft Auto IV sold over 25 million copies worldwide in the five years after its release in 2008, with roughly 50% of its sales in the first year. At one time, Grand Theft Auto V was the highest-selling game of all time by revenue and units in the U.S., according to the NPD Group.

Take-Two Interactive has an A+ Growth Grade of B. The growth grade considers both the near- and longer-term historical growth in revenue, earnings per share and operating cash flow. The company reported second-quarter revenues of $813 million, down 2.2% from $839 million in the year-ago quarter. The company reported quarterly diluted earnings per share of $1.01. Take-Two Interactive does not currently pay a dividend. TTWO has a Momentum Grade of F, based on its Momentum Score of 19.

Zynga (ZNGA) is a company that develops, markets and operates social games as live services played on mobile platforms, such as iOS and Android, and social networking sites, such as Facebook. Zynga generates revenue through mobile game downloads, in-games sales of virtual goods and advertising services. Zynga’s revenue is divided between online games and advertising and other, where online games accounts for the vast majority of total revenue. The firm’s top three games account for the majority of its online game revenue. The company invests in several game categories, such as social casino, including Zynga Poker; casual, including Words With Friends; action strategy, including Empires & Allies; and invest express, including FarmVille. Other offerings in these categories include Free Slots, Hit It Rich, Black Diamond Casino, Chess with Friends, Draw Something, What’s the Phrase, Ice Age: Arctic Blast and Looney Tunes Dash. It provides advertising services comprising mobile advertisements, engagement advertisements and offers, as well as branded virtual items and sponsorships for marketers and advertisers; and licenses its own brands.

Zynga has a Value Grade of D, based on its Value Score of 75, which is considered expensive. The company’s Value Score ranking is based on several traditional valuation metrics. Zynga has a score of 67 for the price-to-free-cash-flow ratio, 75 for shareholder yield and 95 for the enterprise-value-to-Ebitda ratio (remember, the lower the score the better for value). Successful stock investing involves buying low and selling high, so stock valuation is an important consideration for stock selection.

The Value Grade is the percentile rank of the average of the percentile ranks of the valuation metrics mentioned above along with the price-earnings, price-to-book and price-to-sales ratios.

Zynga has a Momentum Grade of F, based on its Momentum Score of 16. This means it ranks in the bottom tier of all stocks in terms of its weighted relative strength over the last four quarters. The weighted four-quarter relative strength rank is the relative price change for each of the past four quarters.

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The stocks meeting the criteria of the approach do not represent a “recommended” or “buy” list. It is important to perform due diligence.

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