I like growth stocks. But I prefer growth stocks trading at discount prices. Enter Activision (ATVI), which offers a very nice "growth at a reasonable price" opportunity, asserts Steve Reitmeister, editor of Reitmeister Total Return.
(Editor's note: Steve Reitmeister is a participant in The Interactive MoneyShow Virtual Event, March 16-18. Register for free here.)
In 2019, the video game market industry was worth $129 billion and expected to grow at a 12.9% annual rate for the next decade. Of course, its popularity only increased during the pandemic in terms of new gamers and time spent gaming.
To take advantage of this trend, investors should look to invest in the best companies in the sector. Activision Blizzard is the top video game studio as it’s behind some of the most popular titles such as the Call of Duty franchise and Warcraft.
They posted very strong Q4 earnings, topping analysts’ expectations for sales, earnings, and 2021 guidance. However, ATVI dipped 8% last week due to the tech-led selloff; this is creating an attractive, entry point for investors given its strong growth prospects and attractive valuation.
Now let’s dig in and appreciate the full story below:
ATVI is simply at the intersection of several positive trends. Video gaming is a massive market and continues to grow at a double-digit rate. There are an estimated 2.7 billion gamers globally who play an average of six hours per week.
ATVI has demonstrated the ability to consistently churn out popular titles. However, the most exciting development is the increasing monetization of its games. It’s doing this by shifting from a product-based model to a subscription-based one.
Additionally, it’s adopting a freemium model for some games. The strategy is to grow a massive userbase and then slowly increase monetization through in-game purchases such as features to improve your game-playing ability or other forms of digital goods which have 100% margins.
Compared to other types of media, the video game market is severely under-monetized. The industry’s valuation is much smaller than similar industries like TV, movies, social media, etc. This is despite the fact that significantly more time is spent gaming by young people.
This means there is more upside for ATVI as it increases the average revenue per user. Its latest hit Call of Duty: Warzone has an estimated 110 million active users. In March, many analysts believe it will generate over $100 million in revenue.
Typically, a leading stock in a rapidly expanding industry is only available at a premium which dents its appeal. However, ATVI is quite attractively priced as it has a forward PE of 22 which is below the S&P 500’s average of 25.5 despite having higher revenue growth and larger margins.
Recently, ATVI dipped 8% due to the selloff in tech stocks due to concerns about the effects of higher rates. While this may be a concern for many high-multiple stocks, it won’t affect ATVI given its below-average valuation.
It’s possible that some tech trends may decelerate following the pandemic’s end, but video gaming is an exception. If anything, the pandemic will have increased the total market size of the industry.
Wall Street analysts are also bullish on the stock as 20 out of the 27 analysts who cover the stock have a Buy or Strong Buy rating. None have a sell rating. The average price target is $114 which implies a 21% upside.
Further, 5 star Brian Fitzgerald of Wells Fargo has a $120 target, while 4.5-star analyst Brian Nowak of Morgan Stanley has a $115 target.
ATVI is rated a B by the POWR Ratings which equates to a Buy. The POWR Ratings assesses stocks by 118 different factors, each with its own weighting. B-rated stocks have generated a compound annual return of 19.7%. This is more than 175% of the S&P 500’s compounded annual return of 7.1%.
The POWR Ratings also assesses stocks based on different categories. ATVI is also rated a B in Momentum. This isn’t surprising considering that analysts have hiked 2021 and 2022 earnings estimates by 30% and 23%, respectively.
Additionally, Call of Duty: Warzone has become the hottest game over the last few months, and many believe the company could increase the average per user by many multiples in the coming years. Further, it has many popular franchises that it could eventually monetize in similar ways.
ATVI also has an Industry Rating of B. This makes sense given that there are 2.7 billion gamers in the world who play an average of six hours a week. Currently, monetization is at very low levels compared to other industries but is starting to show signs of catching up. This development would lead to even higher growth rates than expected.
Some of the best investments are due to buying leading companies in growing industries. Often, these industries grow much bigger than ever could be originally imagined.
This is what makes ATVI so appealing. It has significant upside but is priced attractively. It’s rare to find such opportunities in fast-growing industries.
ATVI has a large share of the video game market but is also growing faster than the overall market at 16% compared to 12.9%. Earnings are growing even faster with a projected 20% annual increase into the future.
Recent market turbulence has created a great buying opportunity even though its Q4 results showed strong momentum and a better than expected forecast.
Gotta love buying a quality company like ATVI on a hearty dip. The shares should have little problems getting back to the previous high of $104, then pressing on to new highs. Don’t even think of taking profits until closer to $120.