There’s No Need to Rush Into Activision Stock

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Video game publisher Activision Blizzard (NASDAQ: ATVI ) reported mixed second quarter numbers after the bell on Thursday, August 2. Investors weren't sure how to react. ATVI stock went up and down in after-hours trade, and eventually settled in the red. So far this morning, ATVI is down 2.5%.

What is the big takeaway from Activision's second quarter report?

Yesterday's big growth drivers from digital downloads and Nintendo Switch hype are winding down. Meanwhile, tomorrow's big growth drivers from eSports have yet to fully materialize on the financial statements. Thus, ATVI stock is somewhat stuck in no man's land in terms of its growth narrative.

Meanwhile, ATVI stock is a bit richly valued. Thus, the lack of a game-changing catalyst on the horizon could result in a pullback in shares. But, if ATVI stock pulls back towards $65, that could be a buying opportunity.

All together, I'm sitting on the sidelines for now. But, I'm ready to buy the dip if we start seeing ATVI stock in the mid-$60's.

Here's a deeper look.

Activision's Quarter Was Just "OK"

At its core, Activision's second-quarter earnings report was rather bland. For every positive, there was a negative, and the whole report somewhat neutralized itself.

Headline earnings came in above expectations. But, headline revenues simply met expectations, which isn't great considering nearly 80% of companies have beat revenue estimates this quarter.

The first half of Activision's year marked records for both revenue and profits. But, revenues were essentially flat in the second quarter and are up just 7.5% year-to-date.

The company's eSports initiatives appear to be picking up momentum. Overwatch League (OWL) just wrapped up its Grand Finals showing, which was a huge success. OWL is also adding two franchises to the league, and both of those franchises sold for record prices. Meanwhile, Call of Duty World League year-to-date minutes watched are up 50%.

On the flip-side, all that positive momentum isn't really showing up in the numbers yet. As stated earlier, revenue growth is consistently sub-10%, while margins are flat. Monthly active users are also down year-over-year across both Activision Blizzard and King.

All together, then, the quarter had some good, some bad, and didn't provide much ammunition to either bulls or bears.

Activision Stock Looks Good Below $65

ATVI stock hit $80 in mid-July. But at those prices, the stock price was way ahead of fundamentals.

Investors were pricing in huge upside from eSports. Granted, this will happen. But, a market as big as eSports will take time to develop, and immediate upside won't be obvious or show up in the financials. Plus, the whole video game market is cooling off now after a red-hot 2017 that was led by super-charged hyped surrounding Switch.

All together, then, Activision's numbers really aren't that great at the present moment. They will get better. But not that much better. Over the past 5 years, revenue growth has hovered around 7.5% per year. Over the next 5 years, I think that moves towards 10%, as eSports related tailwinds more than offset a slower rate of growth in digital games.

Operating margins have expanded a few hundred basis points over the past 5 years. I think that trend persists, mostly due to the digital shift in the gaming world. Roughly 10% revenue growth on top of healthy margin expansion should drive earnings per share to $4.50 in five years.

That isn't enough earnings power to justify a $70-plus price tag today. A historic average 20x forward multiple on $4.50 implies a four-year forward price target of $90. Discounted back by 10% per year, that equates to a year-end price target for ATVI stock of ~$67.

Thus, while ATVI stock has nice upside in a multi-year window, it is also slightly overvalued in the near-term.

Bottom Line on ATVI Stock

The lack of good news in the second quarter earnings report leads me to believe that ATVI stock could enter choppy waters over the next several months. During that time, I think the stock price could fall to below $65.

If that happens, then I'll be buying the dip. Until then, I'm waiting on the sidelines.

As of this writing, Luke Lango did not hold any positions in any of the aforementioned securities.

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The post There's No Need to Rush Into Activision Stock appeared first on InvestorPlace .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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