Investing in the gaming industry presents unique challenges, rooted in its dynamic nature. The sector is marked by swift technological advancements and ever-changing consumer tastes, making it hard to predict which games or platforms will dominate next.

Intense competition means companies are in a constant race to innovate. Even with substantial investments, many titles may not resonate with audiences or achieve expected returns.

Additionally, the industry’s revenue can be hit-driven, with a few successful games often accounting for a significant portion of profits, making forecasting and stability more complex.

So it seems that with all this in mind, every gaming company presents the same risky investment.

Take-Two Interactive Software (TTWO) puts this statement to the test. It is a prominent video game publisher known for producing some of the industry’s most popular and critically acclaimed titles.

Among its main franchises are “Grand Theft Auto (GTA),” “Red Dead Redemption,” and the “NBA 2K” series. These franchises have not only achieved massive sales but have also played a significant role in shaping modern gaming culture.

Next games of these franchises are already known to be winners, creating a predictable revenue stream.

Although these games are huge sources of revenue for Take-Two, their success doesn’t stop there. Currently, Take-Two boasts one of the most extensive product lineups it has ever had across its diverse studios.

Likewise, the company has ventured into the mobile gaming realm, a sector that’s rapidly gaining traction in the gaming world.

Highlighting this strategic move, Take-Two recently acquired Zynga last year for an impressive $12.7 billion. Zynga, a global leader in mobile gaming, holds renowned titles under its belt, such as “FarmVille.”

These growth prospects combined with Take-Two’s recent strong return on assets (“ROA”) show just how strong of a gaming company Take-Two is.

In the last six years, Take-Two had an average ROA of 42%.

Take a look…

The company has performed incredibly well recently. Clearly, as the company continues bringing new games to market and growing its pipeline, it should continue to see increasing profitability.

And yet, the market fails to recognize this opportunity.

We can see this through our Embedded Expectations Analysis (“EEA”) framework.

The EEA starts by looking at a company’s current stock price. From there, we can calculate what the market expects from the company’s future cash flows. We then compare that with our own cash-flow projections.

In short, it tells us how well a company has to perform in the future to be worth what the market is paying for it today.

At the current stock price, the market expects the company’s ROA to fall below 40%, assuming the demand will slow down.

Given Take-Two’s new products coming to the market and the company’s essential portfolio in the gaming industry, these expectations seem overly pessimistic.

Take-Two has substantial potential to scale its operations and continue releasing chart topping games.

That is why Take-Two showed up on our screen. The company makes a great FA Alpha 50 name due to its potential for high returns and low expectations from the market.

Throughout financial market history, many of the world’s most successful investors have been candid in their belief that Generally Accepted Accounting Principles (“GAAP”) distort economic reality.

Warren Buffett, for example, once said investors should “concentrate on the world of companies, not arcane accounting mathematics.”

Investors who neglect the very real issues with as-reported accounting can find themselves caught up in investing with the crowd, blindly following hot “themes” without a thorough grasp of how to understand the businesses in question.

The only true way to focus on the “world of companies,” as Buffett suggests investors do, is to present a clear picture of how a business operates, something that can only be done by adjusting financial statements to reflect the arbitrary nature of certain accounting rules that leave much to discretion.

The world’s best investors understand the need to make these adjustments, which allows them to focus not on picking out the most popular companies but rather on looking for great names in sleepy areas that the market isn’t paying much attention to. From there, the goal is to then identify quality companies with significant growth potential at reasonable prices.

That’s exactly what we’ve set out to do with the FA Alpha, our monthly list of 50 companies that rank at the top for quality, high growth, and low valuations.

This list has outperformed the market by 300 basis points per year for over 20 years now, effectively doubling the performance of the market by focusing on the real fundamentals and valuations of companies with our proprietary Uniform Accounting framework.

See for yourself below.

To see the other 49 names on the list, click here.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

Today’s highlight, Take-Two Interactive Software, Inc. (TTWO) is one of the top stock picks from FA Alpha 50 this month. To see more stock picks like this, become an FA Alpha and get access to FA Alpha 50.