By the end of this year, the gaming industry as a whole is expected to generate around $385 billion in revenue, which is larger than both the filmed entertainment and recorded music industries combined. And analysts even project that the gaming industry could grow at a double-digit rate through 2028. When describing the opportunity, Microsoft CEO Satya Nadella once called it "the most dynamic and exciting category in entertainment across all platforms today."
So with some clear tailwinds behind the gaming market, here are three stocks in particular that look poised to drive strong returns for investors.
Nintendo
Nintendo (NTDOY 0.27%), the company behind hit franchises like Mario, Zelda, and Pokemon, generated 161% returns for shareholders since first introducing the Nintendo Switch in March 2017. But before getting into why those returns could continue, I think it's best to lay the groundwork for understanding the company.
Throughout most of Nintendo's history, the company's sales and profits have been tied to whatever its most recent console was. This led to wonderful results during successful hardware generations, but unprofitable periods if the hardware flopped. Fast-forward to today, and that's largely changed. Although the company's financial results still depend on sales of its most recent family of consoles (The Switch, Switch Lite, and Switch OLED), players are no longer tied to a specific piece of hardware, but instead a Nintendo Switch Online account.
This means that as players upgrade from one Switch console to the next, they can access the same games, not lose progress, and download digital add-on content, among other benefits. With this cloud-based approach, Nintendo's annual playing user base continues to grow despite launching the original Switch hardware more than six years ago. Last quarter the company boasted 114 million annual playing users, which was up 11% from the year prior.
For Nintendo, as this installed base grows, so too will its profits. This should be evident next quarter thanks to the success of its recent title The Legend of Zelda: Tears of the Kingdom, which sold more than 10 million copies within just three days of being released. With that incredible rate of sales, the title became the fastest-selling game for Nintendo ever in the U.S.
Today, Nintendo trades at an enterprise value-to-earnings ratio of roughly 12 times, which is well below the market average. For a business that now looks set to grow earnings well into the future, that's a cheap price to pay.
Electronic Arts
Electronic Arts (EA -0.64%), the video game publisher behind brands like EA Sports FIFA, Sims, and Madden, has seen plenty of success lately. In the most recent quarter, the company generated $1.95 billion in bookings, which was up 15% in constant currency from the same period a year prior.
While EA touts a diverse catalog of games, the company owes much of its recent success to the hit title EA Sports FIFA -- soon to be renamed EA Sports FC. Despite launching its newest version of the game -- EA Sports FIFA 23 -- less than six months ago, the game has already surpassed the lifetime sales of its previous title, EA Sports FIFA 22. Now going on its 30th year of production, the EA Sports FIFA franchise is showing tons of momentum with bookings growing by 31% in the most recent quarter.
However, even with the recent surge in bookings, the stock is still down over the last five years due to a decline in profit margins. The company has been investing heavily to build out its mobile business as well as to establish a strong pipeline of triple-A games like Star Wars Jedi: Survivor, a revamped Battlefield franchise, NCAA Football, and plenty more. This investment is reflected in EA's research and development expenses, which have grown by 13% annually since 2019. By comparison, the company's bookings have only grown by 10% a year during the same period.
As EA begins to recognize sales from its extensive pipeline of games and continues to rationalize costs as it did with a recent round of layoffs, profitability should gradually recover. At its current enterprise-value-to-free-cash-flow multiple of 26, shareholders should see strong returns as margins bounce back and the company continues its long history of sustained sales growth.
Activision Blizzard
For investors who follow the gaming world, it probably feels like Activision Blizzard's (ATVI) stock is in no-man's land right now. Microsoft's $69 billion proposed bid to acquire the company is currently in limbo as the U.S. Federal Trade Commission sued to block the deal. As a result, Activision's stock is still 14% away from the acquisition price. However, it might surprise investors to hear that regardless of the outcome, Activision seems positioned to earn strong returns from here.
In the most recent quarter, Activision Blizzard generated $1.86 billion in net bookings, which was 25% higher than a year ago. But it isn't just the company's flagship Call of Duty franchise that's driving growth for the business -- all of Activision Blizzard's operating divisions grew sales this quarter. In fact, Blizzard, which has struggled in recent years, grew its revenue by 62% year over year and just launched the long-awaited Diablo IV title to record-breaking results. Between its three divisions (Activision, Blizzard, and King), the company is expected to generate roughly $3 billion in cash flow for 2023.
If the deal breaks, Microsoft will likely be forced to pay a fee to Activision Blizzard in the billions of dollars depending on timing. That would leave Activision Blizzard with more than $10 billion in net cash on the balance sheet. So, for shareholders with a long-term investment strategy, it looks like a potential win-win scenario. Either the deal closes and shareholders get a 14% return from current prices, or the deal breaks and shareholders get an established video game publisher that's firing on all cylinders at an enterprise-value-to-free-cash-flow ratio of below 20.
