As we all know, long-term ownership of high-quality equities is a fairly reliable way to build wealth in the markets. However, during tough times, fear creeps into our minds and tries to get us to part ways with our shares. I know that I’ve echoed Jim Cramer in saying that “nobody ever got hurt by taking a profit” many times before, but I think it’s important to note that sometimes selling, even if you’re sitting on profits, can be one of the worst decisions you could make in terms of your long-term financial health.

So, what can we do to help combat such fears? Well, having a great understanding of the companies that you’ve partnered with as a shareholder is a great start. Peter Lynch is famous for telling retail investors that they should “buy what they know.” Knowledge is power. Oftentimes sell-offs in the market are irrational, and if you’re well aware that the operations of the business you own are doing just fine, then you won’t be nearly as tempted to run for the hills with the rest of a frantic market during volatile times.

Furthermore, how could you hope to identify a high-quality business to partner with in the first place, if you didn’t understand its operations? If I remember correctly, Lynch said that you ought to be able to describe how the companies you own make money to a child. He talked about drawing its operations on an index card, and if they seemed too complicated to do this, then you probably don’t understand them well enough.

There’s certainly something to boiling down a company’s operations to its most basic elements. Once you’re able to do this, you’ll be able to understand whether or not issues that arise in the market place are simply isolated incidences that are likely to pass or problems that are truly concerning and could develop into secular issues.

So, with this in mind, I think it’s important to ask ourselves, which sectors/industries/individual companies are we most familiar with? Obviously, over time, you will expand your knowledge base and feel more comfortable with your knowledge of a myriad of industry/individual company practices, yet when someone is just starting off, I agree with Mr. Lynch: it makes the most sense to start off owning stocks of companies that you know.

This is why I always get excited when I decide to sit down and write an article about a video game company. Games have always been a big part of my life. I’m ashamed to say just how many hours of my life that I’ve spent immersed in different digital worlds and settings. And now, with the invention of media platforms like Twitch and the rise of celebrity gamers on platforms like YouTube, I’m able to spend even more time thinking about and learning about an industry that I love. Without a doubt, I feel as if I’m very well versed on the gaming industry at large.

However, over the years, I’ve rarely bought any of the companies that I know so well because of the valuations that they’ve historically traded at. Gaming is a growth industry and for most of my relatively short investing career, these companies were assigned high premiums by the market. But, in the recent past, things have begun to change and because of that, I wanted to re-visit Activision Blizzard (NASDAQ:ATVI), which is the only large U.S. video game pure play that is also a dividend growth company.

The gaming industry is changing rapidly. Some of the old guard producers are producing flops. Studios are changing hands. Big companies like Apple (NASDAQ:AAPL) and Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) recently announced their own gaming platforms. And certain old school franchises are losing their momentum (including Call of Duty, one of Activision Blizzard’s crown jewels). We’ve seen the battle royal game mode take over the first person shooter space with Fortnite rising to prominence, and since then, this game mode has been a very crowded space (recently, I’ve been playing Apex, produced by Electronic Arts (NASDAQ:EA) and I love it). Activision hasn’t been able to carve out meaningful market share in this popular area of the gaming space and this concerns investors.

Because of all of this volatility within the gaming industry, I think we’ll see consolidation in the near future. For years now, we’ve seen all of the big tech names focus on the media/entertainment space with OTT platforms and original content. Well, that space is about as crowded as you could ever get, and I think the next likely frontier is the gaming space. Granted, I’ve been saying this for years and, thus far, I’ve been wrong (there haven’t been any major M&A moves made in the video game space). Yet, prices were elevated and now they’re much cheaper, which might make a name like ATVI look more attractive to a potential buyer.

I don’t think it’s a good idea to ever buy shares of a company hoping for a buyout. Sure, if ATVI were to get an offer tomorrow, shares would likely skyrocket double digits. However, that offer might not ever come (or, ATVI could be a buyer). This is why I think it’s always a good idea to want to own the companies that you’re buying in the market, rather than speculation on M&A premiums.

I think this is especially the case when it comes to gaming names because while I do think there is value in certain IP and long-played franchises, we’ve seen so many new entrants making big splashes in the market in recent years that I’m not sure if there is such a thing as a moat in this industry. Gamers seem to be more loyal to their experience (and the latest games being highlighted by influencers on social media and streaming platforms) than characters, settings, storylines, or universes of their gaming past. Frankly put, I wouldn’t be surprised to hear that it is simply cheaper to build a game from scratch than it is to buy an existing studio.

Gaming IP doesn’t see the same merchandising as content from other entertainment. And, there doesn’t seem to be as much successful crossovers with content (turning gaming IP into a movie, for instance) in this space as there is with other story telling mediums. To me, this lowers the value of the gaming IP and makes me question the value that a major studio like ATVI might have to a name like Apple, Alphabet, or even a Disney (NYSE:DIS) (though, I have to admit that I think that the creative minds at Disney could work absolute wonders with the World of Warcraft and Overwatch universes; here’s an article I wrote in July of 2018 talking about how I thought that e-sports could save ESPN).

I was interested to hear recently that ATVI is looking to bring Call of Duty to mobile. I’m honestly not quite sure how successful that will be because of the game play expectations, but I think it’s a great step into the future of gaming. The Nintendo Switch is very popular in large part because of its mobile capabilities. Considering that we basically all carry around smartphones with us at all times, the focus on mobile games makes the most sense to me.

It has the broadest global market, technology is increasing in the mobile phones, making them powerful enough to handle games previously thought of as console/PC only, 5G is on the way, which should increase the mobile gaming capabilities even further, and I think there’s an existing culture of micro transactions on phones/the app stores which gaming companies like ATVI can take advantage of.

Even if Call of Duty on mobile isn’t the next big thing in gaming, I think beginning to understand this market is important for ATVI. I also think some of its other content could portal to mobile very well. Vanilla World of Warcraft, for instance, seems like a great mobile game to me. The graphics aren’t out of this world, the game is multi-player/social in nature, and even if ATVI gave us a light version, with just say dungeons, raids, city hubs with an auction house and vendors, I’d be all over it. I can’t imagine a world where ATVI couldn’t make incredibly high margins selling bags of digital gold to its World of Warcraft clientele if it made the jump to mobile.

So, while I think there is major potential in the gaming space still, it’s fair to admit that competition is heating up, the value of IP is dropping (in the short-term, at least), and the future of the industry is facing unprecedented uncertainty. Are we headed towards a console-less world where all games are purchases a la carte on some big tech company’s gaming streaming platform? Will mobile gaming take over more than it already has? Or, will the hardware continue to improve with graphics (and eventually offer augmented and virtual reality), keeping the sales of gaming consoles and PCs alive for years and years to come? Frankly put. I don’t know. That’s why, I think it’s more important than ever, not to speculate on names in this space, but instead, pay close attention to value and the margin of safety you’re receiving.

I’ve owned Activision shares before. I built an ATVI position using selective monthly re-investment from July-November of 2017. Shares were relatively expensive when I purchased them, but I wanted exposure because I thought that ATVI had a bright future with e-sports emerging and several new titles, including Overwatch, that I felt were adding significant value to its IP portfolio. By building a position slowly, over a handful of months, using my dividends I was essentially dollar cost averaging into the name. Eventually, I built what amounted to a ½ position, but I stopped buying shares during 2018 because the shares shot up past $70 and I felt that they had gotten way ahead of themselves at ~30x+ earnings.

When weakness appeared in the name early in 2018, I sold out of my position, locking in very small gains (when the tide began to turn, I basically set a limit order on these shares so that I would avoid a loss). I still liked ATVI’s IP, but I was worried about the market volatility, and I wanted to trim down my exposure to high valuation growth names and redeploy that capital to natures with higher dividend yields that were more defensive in nature. I sold my shares at $66.08. The stock rebounded alongside the rest of the market and traded well throughout 2018. For a short while, I regretted selling my shares. But I kept reminding myself why I did so and regret turned into gratitude as I watched the stock from afar.

I didn’t expect to become interested in the stock so soon, but after peaking at nearly $85 (and a trailing twelve-month P/E ratio of more than 33x), ATVI’s momentum took a shark turn for the worse late last year and that negative sentiment drove the stock down from ~$85 to the ~$45 level where it sits today. ATVI’s EPS growth was strong in 2018, at 14%, but analysts are expecting negative 16% EPS growth in 2019, which is why the stock fell. The gaming industry names went from market darlings to dogs.

These days, ATVI is trading for 18x ttm earnings. On a forward basis, shares are a bit more expensive (at 21x 2019 EPS expectations of $2.17/share). However, looking even further ahead to 2020 and beyond, analysts are more bullish, calling for 19% EPS growth in 2020 and 14% on top of that in 2021. ATVI’s shares are trading for just 15.5x that 2021 figure. Typically, I don’t feel comfortable looking so far down the road, but then again, I am bullish on the gaming space long-term and time is on my side as a relatively young investor.

Source: F.A.S.T. Graphs

Even after recent weakness, ATVI’s dividend yield is rather low at 0.81%. The company has increased its dividend every year since 2010, and over the last nine years, the company has produced a dividend growth CAGR of 9.5%. ATVI’s payout ratio is incredibly low at ~13%. This low payout ratio combined with strong future EPS growth expectations leads me to believe that ATVI can continue to increase its dividend for years to come. It’s probably too soon to tell just how committed management is to becoming a dividend aristocrat and dedicating a higher percentage of its cash flows to shareholder returns. But, as I said before, this is the only major gaming pure play that pays a dividend, so if you really want exposure to video games and want to own something other than Microsoft (MSFT) or some of the chip name, ATVI is about your only other option in the DGI space.

Source: F.A.S.T. Graphs

So, after falling some 47%, I have to ask myself, if ATVI is worth owning again? Unfortunately, that answer isn’t a clear one. I think the stock is attractive here now that it’s stabilized in the ~$45 area. I love selling a stock for a profit and then buying it back lower. That always feels great. However, even though I think ATVI could represent attractive value here, there’s a caveat to consider: I don’t think that ATVI can be viewed as anything more than a speculative growth play, with a dividend growth kicker (until it proves otherwise with a more established dividend growth story).

I think there is major upside potential after recent weakness, but then again, I can also imagine a future where a name like this gets crushed by bigger, badder, and richer (big tech) competition. Because of this, I think owning a position in ATVI comes down to one’s risk appetite. Right now, I’m not operating with a particularly high risk-on mindset. I’m content to sit on the sidelines for now. If ATVI shoots back up towards prior highs and I miss out on this weakness, that’s okay with me. But, if you’re someone who is looking to spice up your DGI portfolio with some gaming exposure, I think ATVI is worth looking in to.

This article was previously published for members of The Dividend Growth Club.

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Disclosure: I am/we are long AAPL, GOOGL, MSFT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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2019-04-06