To no one’s surprise, video game stocks have been big out-performers amid the novel coronavirus pandemic, as consumers forced to stay inside their homes have spent more time (and money) on video games over the past few months. Nintendo (OTCMKTS:NTDOY) stock has been no exception to this trend. If anything, it has been leading the video game rally, with NTDOY stock up about 10% year-to-date.
This rally won’t end here.
Recent strength in the stock will persist for the rest of the year. For five big reasons:
- While the coronavirus pandemic will gradually fade, consumer behavior for the rest of 2020 will remain slightly impacted, resulting in higher video game engagement and spend for the rest of the year.
- Nintendo will sell a lot of Switch console gaming systems over the next few months.
- Nintendo will also sell a lot of Switch video games over the next few months.
- The potential launch of the Switch 2 (or Switch Pro) gives the company a strong 2021 upside catalyst. Investors like to bid up strong stocks with big catalysts on the horizon.
- The valuation on NTDOY stock remains reasonable considering the company’s strong long-term growth prospects.
As such, while I don’t like to chase rallies, I do think that NTDOY stock will finish the year way higher than where it trades today. I say wait on the sidelines for a dip. But when that dip comes, be ready to buy.
This Video Game Surge Has Staying Power
In March, U.S. video games sales roared 35% higher to their highest level since 2008. That’s a big jump. While 35% growth won’t be the norm from April to December, steady 10%-plus growth should be.
Yes, the coronavirus pandemic is temporary. Over the next few months, the economy will gradually re-open, consumer behavior will gradually normalize, and we won’t all be stuck inside playing video games.
Still, consumer caution will stick around. Had you asked high school students in January whether they wanted to stay inside on Friday night and play Call of Duty online, or go out to a party, and their answers would overwhelmingly be the party. Ask that question again in October, November, or December. You’d probably get a split response.
As such, I expect current strength in video games sales to persist for the rest of the year, and especially perk up towards the end of the year, with the launch of new gaming consoles.
Nintendo Will Sell A Lot of Switches
In the red-hot video game market of 2020, Nintendo will sell a ton of Switch video game consoles.
Nintendo released the Switch gaming console in 2017. Three years later, it’s still the hottest hardware in the video game sector, which demonstrates impressive longevity. Last month, the Nintendo Switch set a March monthly sales record, with sales up more than 100% from a year ago.
Over the next few months, it’s likely that demand won’t fall-off. Nor will it fall-off with the release of the Xbox Series X or PlayStation 5 during holiday 2020. The Switch is a fundamentally differentiated gaming console, aimed at a fundamentally different gaming audience than the Xbox or PlayStation.
As such, it’s very likely that Nintendo Switch demand remains robust for the rest of 2020, powering strong hardware sales at Nintendo over the next few quarters.
They Will Sell A Lot of Games, Too
More important than selling a ton of Switches, Nintendo is bound to sell a ton of Switch games, too.
When you buy a Switch, you buy it to play all the re-purposed classic Nintendo games, like Mario Kart, The Legend of Zelda, Luigi’s Mansion and Super Smash Bros.
As demand for Switch consoles rises over the next few months, so will demand for these classic Switch games. And that’s important because software sales are higher-margin than hardware sales, meaning that Nintendo’s software video game sales will be the driver of profits going forward.
From this perspective, the more Switch games Nintendo sells over the next few quarters, the higher profits will go, and the higher the stock will go.
Switch 2 Catalyst on the Horizon
The Switch was the best thing to ever happen to Nintendo. The Nintendo Switch launched in March 2017. Since then, NTDOY stock has doubled.
From this perspective, investors should be reasonably excited that the Switch 2 (or Switch Pro) is expected to launch in 2021. This gaming console is expected to include significant upgrades from the first Switch, and be catered towards the hardcore gaming crowd.
It’s unlikely that the Switch 2 has the same hugely positive impact as the first Switch. Still, it should have some positive impact, and provide a meaningful lift to the company’s sales and profits in 2021.
Ahead of that catalyst, investors will likely continue to bid-up Nintendo stock in 2020.
According to my numbers, the stock remains reasonably valued relative to the company’s long-term profit growth potential.
Broadly, I see the video game market growing at a high-single-digit compounded annual growth rate over the next five years, with Nintendo leveraging best-in-breed hardware and a strong software content portfolio to drive market share expansion and 10%-plus revenue growth. Gross margins should improve with strong software sales, and positive operating leverage should allow for opex rate compression.
Assuming so, my modeling suggests that Nintendo will net $4.50 in earnings per share by 2025. Based on a 23-times forward earnings multiple — which is about average for video game stocks — and a 10% annual discount rate, that implies a 2020 price target for NTDOY stock of $70.
Bottom Line on NTDOY Stock
Video game stocks are broadly good buys in 2020. In that category, one of the better stocks to buy is Nintendo, given the company’s strong hardware business, stronger software business and big 2021 catalyst with the launch of the Switch 2. It also helps that the stock is attractively valued.
Yes, the stock has run up quite a big hill during the coronavirus pandemic. I’m not saying you should chase this rally. But, if/when the stock does dip on turbulence, buy that dip.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he did not hold a position in any of the aforementioned securities.