If you are looking for pure-play video game developer stocks, you can’t get much bigger than Take-Two Interactive Software Inc (NASDAQ:TTWO), the third largest by market capitalization.  

Only Activision Blizzard, Inc. (NASDAQ:ATVI) and Electronic Arts Inc. (NASDAQ:EA) are larger than TTWO.

Take-Two stock has outperformed the two this year, up 137% year-to-date, ahead of both Activision Blizzard (up 82%) and EA (up 36%).

Take-Two develops games for a variety of platforms, including the Playstation, which is owned by Sony Corp (ADR) (NYSE:SNE), and the Xbox, which belongs to Microsoft Corporation (NASDAQ:MSFT).

Take-Two also targets the PC, tablet and smartphone markets, but 82% of its revenue in the six months ending on September 30 came from Playstation and Xbox games.

 

Take-Two makes some of the world’s favorite video games, including Grand Theft Auto, NBA 2K, BioShock, Mafia, and Sid Meier’s Civilization. According to Take-Two’s earnings release, Grand Theft Auto V has sold over 85 million copies.

Over the past five years, pure-play video game stocks have shot upward. TTWO stock rose 889%. Ubisoft Entertainment SA (OTCMKTS:UBSFF), creator of the Assassin’s Creed series, soared 747%. EA stock rose 740%, and ATVI stock climbed 497%.

Revenues haven’t quite kept up with this pace; according to Morningstar, Take-Two stock traded at 0.88 times sales in 2012 and a multiple of 2.73 just last year. Now the stock trades at 7.1 times sales.

But the growth story remains compelling: As incomes rise and more people acquire PCs and gaming consoles, demand for video games will rise as well. Is Take-Two Interactive stock a buy?

Pros for Take-Two Stock Pros

Popular Game Franchises: According to Take-Two’s 2017 Annual Report, 11 of Take-Two’s video game franchises have at least one game that sold 5 million units. As of last year, the Grand Theft Auto series had sold over 250 million units since it premiered in 1997.

Thegamer.com ranks Grand Theft Auto as the fifth best-selling video game series of all time. Take-Two purchased Sid Meier’s Civilization in 2004 for $22.3 million, and according to the company’s annual report, Civilization VI has sold over 2 million units.  

Rapid Growth: According to Finviz, Take-Two has grown sales over the past five years at a 16.6% compound annual rate. Over that same period of time, Activision grew sales at a 6.8% compound annual rate, while Electronic Arts managed a 3.2% annual growth rate.

Transition to Digital: Video games nowadays tend to be distributed digitally via a platform such as Xbox Live or Steam. You no longer need to go to the store and buy the disk; you can pay for and download the game onto your PC.

Take-Two is making this transition. According to Take-Two’s recent earnings release, “digitally-delivered net revenue grew 31% to $302.9 million, as compared to $230.8 million in last year’s fiscal second quarter, and accounted for 68% of total net revenue.”

Cons for Take-Two Stock

Relatively Low Profit Margin: Although high profit margins tend to attract new entrants into an industry, they show that the company has high pricing power. The lower the margins, the more competitive the industry.

As TTWO notes in its 10K, “the interactive entertainment software industry is highly competitive.” Its margins reflect this; over the trailing 12 months, Take-Two managed a 6.64% net margin.

Take-Two’s competitors, EA and Activision, earned higher net margins; 23.3% for EA and 15.9% for ATVI.

Valuation: TTWO is no Netflix, Inc. (NASDAQ:NFLX); still, by some valuation measures, the stock looks pricey. TTWO trades at 107.7 times earnings and 7.1 times sales.

And when a stock rises 137% in 11 months, investors start worrying about the possibility of a bubble. Has the market become too excited? Have investors gotten ahead of themselves?

As I mentioned earlier, TTWO stock wasn’t always this frothy, trading at 2.73 times sales last year and 0.88 times in 2012.

Investorplace contributor Ian Bezek holds a similar view. In an article on EA published in September, he called video game stocks “too hot.”

Dependence on Grand Theft Auto: Investors are taught not to put all their eggs in one basket. If this principle applies to investors, shouldn’t it also apply to firms? Take-Two relies heavily on the Grand Theft Auto franchise for its revenue. 

As Take-Two states in its 10K filing, “Grand Theft Auto products contributed 38.2% of our net revenue for the fiscal year ended March 31, 2017.”

Bottom Line on TTWO Stock

I’m hesitant to buy a stock that has soared 137% in 11 months; how much longer can this rally continue? Do you want to buy into a rally that is already underway and might be ending soon?

However, there is an upcoming catalyst. Take-Two subsidiary Rockstar Games plans to release Red Dead Redemption 2 in the spring of 2018.

And it has been 4 years since the release of Grand Theft Auto V. Take-Two announcing the next game in the series would be massively bullish for TTWO stock.

Still, if I were going to look for a stock in the sector, I’d start with Sony. Sony is a major player in gaming and consumer electronics in general. SNE stock trades at low multiples; 0.8 times sales, 2.42 times book value, and 9.23 times free-cash flow. That may prove to be a better value. 

As of writing, Lucas Hahn did not hold a position in any of the aforementioned securities.