Gaming Stocks: The Future of Profitability?

Regarding a long-term outlook, EA’s current price is right above the $15 level, which has held as a support line for several years. It also is very close to the 38.2% Fibonacci retracement level off of the October 2011 decline. Therefore, from both an Elliotician’s and a chartist’s point-of-view, we can conclude that EA is standing on a significant milestone. The main question though, is will it go higher from here, and if it does, how high? The natural price targets will be the 50% Fibo level (at $16.80) and the 61.8% mark ($18.20). Getting there seems historically logical, as the 50% Fibo was a clear resistance line during the latter half of 2010, and the 61.8% Fibo was an upper-range resistance level that was convincingly broken by March of 2011. Using common technical indicators, we can see that both the MAC-D and the moving averages are turning up: in the case of the MAC-D, the black line is leading the signal line, which is indicative of positive momentum, whereas with the moving averages, the faster 50 DMA appears to be building kinetic energy to eventually cross above the 200 DMA. Since EA has had a strong run over the past few weeks, I’d like to wait for a pull back before initiating a position, but from a technical perspective, I like this share as a momentum play.

For a long play, Electronic Arts has many questions that make me hesitant: first, the Earnings Per Share (EPS) is dismal: only 0.01. Conversely, the P/E ratio is a scorching 25! This suggests that either the shares are overvalued or the company has wildly optimistic growth expectations. I believe the company is a worthwhile endeavor but it does have stiff competition: despite a strong and profitable lineup, such as EA Sports, it faces a behemoth in Activision, where their Call of Duty series rakes in billions. And despite the astounding success of Modern Warfare 3 and Black Ops 2, Activision shares are in decline: the whole industry is in decline! Chasing after the last morsel of water in a receding Amazonian lakebed while the burning sun radiates its aura of dreadful inevitability is not my idea of a sustainable investment strategy.

A better long-term alternative may be Leapfrog Enterprises, or ticker symbol LF:

LeapFrog is an educational entertainment company that specializes in designing products for young children (infants to grade school students) and therefore represents a more socially responsible business entity; in other words, there’s no wanton violence involved and LeapFrog products presumably do not have a corrosive effect on young minds. This may be a key differentiating factor in an otherwise declining industry.

For the fundamentals, one metric that stood out was the PEG ratio, which is currently rated at an attractive 0.46: 

Technically, LF has had a strong one-year run dating back from August of 2011. The current decline in price action could be a consolidation of those gains and while the most recent closing price represents a possible advantageous entry point, the stock could decline further. We may see prices go down to $5.50 but probably no less than $4.40 where the 38.2% Fibo retracement level off of the April 2010 drop resides. 

Overall, shares of gaming companies could be a profitable momentum play, but I would exercise caution when it comes to a long-term perspective. Smart phones and other wireless products are making console gaming systems look dated, and a new paradigm in digital entertainment can shake this industry to its core. It is true that some companies offer enticing technical pictures that may tempt investors to open their wallets: all I’m saying is watch the clock as well!