The selloff was a reminder on just how fast everything can change. In eight trading sessions, the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) fell roughly 10% from its 52-week highs, dragging down winners like Activision Blizzard, Inc. (NASDAQ:ATVI). ATVI stock had finally blasted through resistance and was enjoying a run to new highs.
An impressive earnings report from Electronic Arts Inc. (NASDAQ:EA) in January was fuel to the bullish fire. After hitting a high just under $75 though, on Tuesday ATVI stock found itself back at its breakout level near $67 to $68. After a slight bounce, some maybe wondering if now is the time to load up ahead of its Thursday earnings report after the close.
If you’re bullish on video game stocks, perhaps it is.
Valuing ATVI Stock
At 27 times forward earnings, it’s hard to make the case that ATVI stock is particularly cheap. Analysts are looking for 13% earnings growth in 2018, which is far better than the 3% growth the company will likely turn in for 2017. On the revenue side though, growth is forecast to slow from 7% to 5%.
For the current quarter, analysts expect earnings of 93 cents per share on revenue of $2.55 billion. However, I expect the company to top estimates. For starters, it hasn’t missed an earnings or revenue estimate in six quarters.
Second, results from companies like EA and Advanced Micro Devices, Inc. (NASDAQ:AMD) have been strong. EA’s guidance was solid too, painting a good picture for the video game industry.
Take-Two Interactive Software, Inc (NASDAQ:TTWO) reported after the close on Wednesday and its results were good (although confusing) as well. So that leaves little reason to think Activision’s results won’t be strong as well.
After a powerful launch that included including $500 million in sales in in its opening weekend, Call of Duty: WWII was the top-selling game of 2017. But that wasn’t the only top-five title for Activision stock. Coming in at No. 3 was Destiny 2. So as the trend continues to lift game-makers, I’m confident Activision also had a strong quarter.
Admittedly, on an earnings per share basis Activision stock isn’t cheap. But it does kick out a handsome amount of free-cash flow (FCF). In fiscal 2016, ATVI generated more than $2 billion in FCF. With a fiscal-year-to-date total of almost $1 billion, I’d expect that FCF figure to be close to last year’s mark.
Margins and cash flow are rising thanks to in-game purchases, subscription services and higher engagement. No one does it better than Activision in this department.
Trading ATVI Stock
Nimble investors may be have been able to buy the pullback in ATVI stock. On Tuesday, shares fell right down to the previous breakout level before bouncing higher. I’m not a big believer in trading a stock before earnings, but with ATVI stock, it’s tempting.
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The charts are rather obvious with Activision stock. Stay long over the breakout level of $67 to $68 and exit on a close below. The upside target is new highs above $75. Thus, the obvious problem present is earnings, as the event will likely determine traders’ fate outside of market hours.
The best reaction we can get if we’re not long? A slight pullback and hold of the $67 to $68 level. This will reaffirm the support levels. If we’re already long, obviously we want earnings to act as a launch pad to fresh highs.
So what if earnings don’t work out? $60 was previous channel support, but I think the downside is more limited than that. At the very worst, I see a pullback to $62 holding. The 100-day and 50-day moving averages sit at $65 and $66.50, respectively. Those should be additional layers of support. The 200-day sits at $62.20 and should also serve as support.
Despite the earnings risk, I want to be long Activision stock. There are too many layers of support nearby and the secular story remains strong. If EA and TTWO can succeed, so too should ATVI. But buyer beware: Those who buy should be investors comfortable owning the stock longer term, particularly if shares do pullback.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell did not hold a position in any of the aforementioned securities.
