As the videogame industry's annual trade show E3 roars on in Los Angeles, interest in the industry is spiking once more among analysts.
The combination of big media attention, promising upcoming titles, and the excitement surrounding virtual reality—plus business models that are usually more profitable than other media these days—is enough to to get Wall Street's attention.
"More people are playing games every day and spending more money on games, unlike almost every other form of media, where there's downward pressure," said Colin Sebastian, senior research analyst with Robert W. Baird & Co. "Games are still a growing industry and [they're] becoming more dynamic....Video games should be near the top of the lists of investors."
But the sector is more complex than it might seem on the surface. If you're considering putting money into the industry, here are a few things to keep in mind.
As virtual reality headsets gear up to make their latest debut, there has been a lot of attention surrounding the companies at their forefront: Facebook-owned Oculus, Sony and Valve and HTC. Each offers a slightly different experience, but analysts say the real battle may come down to price.
"There are still a lot of questions around price points for VR," said Sebastian. "A $1,500 Oculus platform is going to have a very limited market. If [Sony's] Morpheus [for the PlayStation 4] sells for a couple hundred dollars and is a better add-on for the PS4, that could be interesting. There are a lot of details to be worked out, but I think in a couple years, that could be very relevant."
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Consistency is worth keeping an eye on too. Sony's Morpheus offers the same experience to all users, since it runs on a common platform. The quality of the experience from Oculus' and Valve/HTC's offerings will depend on the computer you have running the software.
Despite the dramatic growth in mobile just about everywhere, game publishers who focus on the mobile space haven't been the heroes of Wall Street.
Larger publishers with strong mobile divisions, like Electronic Arts, might be worth a look, but analysts say it's generally a waste of time to look at what companies are doing with cell phones, since those are largely the playground of casual companies, which are very hit and miss. Look instead at tablets, where the real progress is being made.
"[Traditional publishers] are doing a better job of addressing the tablet space, because tablets provide a lot more flexibility to do things, said Eric Handler, senior equity analyst at MKM Partners. "Cell phones are still very much a casual space for games."
The days of one-and-done software are long over; now, a retail release is just the beginning for a product. The real money can often be found in downloadable content (DLC).
If a game hooks a player, they're more likely to purchase add-on map packs and levels (among other things). That can boost the overall amount paid for a game from $60 to $100 or more. And while publishers do have to pay a percentage of those digital sales to Sony or Microsoft (they generally skip the Wii U for these franchises), the game makers also save on shipping and packaging.
"Total revenues, in many cases, is actually pretty similar to what it was years ago, but operating profits are higher," said John Taylor, managing director of Arcadia Investment Corp. "The gross margin on digital is up 20 points—and [companies] like Activision and EA, who have built strong marketing platforms, have been able to keep their sales and marketing in check. ... DLC is important for both keeping margin expansion and earnings growth above revenue growth potential."
It's energizing to find a company that is on the verge of taking off. But in the video game world, those companies are almost always privately-held. Small publicly traded publishers—hamstrung by their own finances—tend to stay small.
The mantra of the modern gaming world is "go big or go home." Players no longer buy mediocre games as they did 10 years ago, in part because the titles they enjoy keep them hooked longer with that aforementioned DLC.
"In some ways it's like the movie industry," said Handler. "If you're going to make a big game, you have to spend $80-$100 million-plus to make the game, then another $50-60 million marketing it, and you need good critical reviews and consumer acceptance. If you do get that, you can make a good return."
Here's the real bad news: Most gaming stocks hit their lows for this generation long ago, meaning if you're looking for a quick turn stock, you're likely out of luck.
The console industry is ramping up to its sweet spot in the cycle, where mainstream consumers really become interested in the systems as hardware prices drop and software libraries are sufficiently broad. As the systems start to age and sales growth begins to slow, that's typically when stock prices fall, only to soar again with the next generation of systems and consumer interest. And there's no telling when that will hit.
"The videogame sector is very much product and momentum driven," said Sebastian. "If you're getting invested now you've already missed a lot of the cyclical run in the stocks. ... The question is: How much is left in the tank?"