Is this growth stock on track for a major upside?

After outperforming major indexes for most of the past decade, shares of the leading video game producer Interactive Take-Two (TTWO -1.61%) have dragged the market over the past three years. The stock is currently at the same level it was trading at this time in 2019, while the S&P500 the index is up more than 40% over the same period.

Over the past 10 years, the success of Take-Two Grand Theft Auto V leads to phenomenal returns for shareholders. A $1,000 investment in 2012 would be worth over $12,000 today.

The stock’s underperformance this year parallels the industry slowdown. Market researcher Newzoo expects total industry sales to grow just 2% in 2022. 3.2 billion gamers worldwide.

Take-Two’s strategy is to expand its roster of games to launch a large network for a wider audience, but that’s not all it has to offer. Not only can Take-Two grow in line with the industry, which has averaged around 10% annualized growth over the past 10 years, but the company can do better given its record sales expansion. of games in its biggest franchises.

Take-Two Game Sales Review

Take-Two’s most popular game is Grand Theft Auto. The first episode of the series originally launched in the 1990s, and every episode since then has generated bigger sales.

The franchise’s cumulative sales stand at 380 million copies, according to Statista. Grand Theft Auto V (2013), the latest iteration of the series, is responsible for around half of the franchise’s lifetime sales, selling 170 million copies in the last quarter.

Investors should expect Grand Theft Auto VI, which is confirmed to be in development, to sell at least that many copies. The opportunities to monetize that massive playerbase with additional content in the next installment on next-gen consoles is one reason to love Take-Two’s stock right now.

Grand Theft Auto is produced by Take-Two subsidiary Rockstar Games, which also created Red Dead Redemption. The 2018 release of Red Dead Redemption 2 shows the same pattern of increasing sales. The second installment of the action-adventure game has sold 45 million copies to date, more than half of the cumulative sales of the red death series.

Another growing franchise is the NBA 2K series, which has sold a total of 125 million copies since the first release in 1999. Not all versions of this annual basketball series have sold better than the previous one, but the game has seen phenomenal growth over the past 10 years, with recent titles selling over 10 million copies each. , far better than the few million each version sold before 2010.

Graph showing that sales of Take-Two's top games have sold hundreds of millions of copies.

Take-Two’s expansion strategy

The company’s spending on research and development (R&D) as a percentage of revenue has increased dramatically, from around 7.5% to nearly 13% over the past decade. Take-Two has also made several acquisitions to expand its roster of studios to bring in more game development expertise, most recently acquiring mobile game maker Zynga.

More importantly, Take-Two made these investments while steadily improving its operating margin and free cash flow. Over the past year, free cash flow has fallen, but this reflects an increase in R&D spending to prepare for new releases.

Take-Two spends very little on superfluous items like fancy corporate offices. Instead, management is investing resources in marketing and game development, and the company’s stock performance over the past 10 years shows that management knows how to create long-term returns for shareholders.

If the industry can grow in line with its past record, Take-Two should grow even faster, perhaps closer to a mid-teens annualized revenue growth rate. That could send the stock, with a current market capitalization of $21 billion, to cross more than $50 billion in the next five years or so.

Yes, Take-Two’s track record and rising R&D spending suggests this top video game stock is poised for a major bull run.

John Ballard has no position in the stocks mentioned. The Motley Fool holds posts and recommends Take-Two Interactive. The Motley Fool recommends the following options: Long Calls January 2023 at $115 on Take-Two Interactive. The Motley Fool has a disclosure policy.

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