Is this smoking-hot small-cap about to crash after six-bagging in one year?

Paul Summers is optimistic on this high-flying games publisher’s future, but cautious when it comes to the valuation.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

The price of stock in Cambridge-based, AIM-listed, games creator and publisher Frontier Developments (LSE: FDEV) has been on fire recently, rising sixfold since this time last year.  

In the last month alone, the shares have almost doubled following news that the company has entered into a subscription agreement with Chinese internet giant Tencent, giving the latter a 10% share of the former in return for £17.7m. This move will allow Frontier access to an absolutely huge entertainment market as well as the cash it needs to continue growing its number of franchises.

Even more recently, Frontier announced its plan to release a game to tie in with next summer’s release of likely blockbuster Jurassic World: Fallen Kingdom. Available on PC, Xbox One and PlayStation 4, Jurassic World Evolution will be the £420m cap’s third major self-published game franchise and will begin contributing to revenues in the 2018/19 financial year.

Given recent developments, it’s therefore not surprising if investors were eager for today’s final results. And what a superb set of numbers they were.

Over the 12 months to the end of May, revenue jumped 75% to £37.4m, thanks largely to the launch of the company’s second franchise (Planet Coaster). Its first franchise — Elite Dangerous — “continues to perform well,” according to Frontier having been added to the Sony PlayStation 4 platform in June. 

The percentage growth in operating profit achieved by the company was even better, rising 550% to £7.8m over the reporting period (representing a 15% rise in margin compared to that achieved in 2015/16).

With figures like these, it’s perhaps not all that surprising that it ended the period with a net cash balance of £12.6m — almost 50% more than it had at the end of the previous financial year. 

As far as the future outlook is concerned, Frontier reiterated its desire to continue evolving and create “a self publishing multi-franchise success story“. Its understandably bullish CEO David Braben reflected that the company’s transition to a business-to-consumer developer over the last year had gone according to plan and that it is now aiming to double its output to ensure that this performance can be repeated. In a statement likely to delight those already invested, Braben also spoke of how his ultimate goal for the company was for it to emerge as a “global leader in entertainment,” highlighting the aforementioned cash injection from Tencent as pivotal for this to be achieved.

Still worth buying?

So, exciting times ahead. The question, however, is whether the shares still represent a decent investment after such incredible performance over the last year. With a trailing price-to-earnings ratio of 53, it would appear that a huge amount of optimism is already priced-in.

Given that disappointment often follows hype in the investing world, are the shares about to crash? Not necessarily. The gaming market — although subject to fads and fashions like anything else — appears both resilient and likely to grow massively over the medium-to-long term with the gradual adoption of virtual reality. Just look at the progress made by Keywords Studios over the last few years for evidence of how long stocks in this industry can continue defying gravity.

That said, even though there’s clearly a lot to like about this one, I’d be disinclined to invest right now. Should this seemingly perpetual bull market come to an abrupt halt, however, it would certainly be on my radar.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

Paul Summers owns shares in Keywords Studios. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Young woman working at modern office. Technical price graph and indicator, red and green candlestick chart and stock trading computer screen background.
Investing Articles

Should I invest in the FTSE 100 – or try to beat it?

Our writer has the option of investing in a FTSE 100 tracker fund. So why does he choose to buy…

Read more »

Young black woman walking in Central London for shopping
Investing Articles

£1,500 to invest in a Stocks and Shares ISA? Here’s how I’d do it

Our writer has been investing in his Stocks and Shares ISA. Here he details how he could put £1,500 in…

Read more »

One English pound placed on a graph to represent an economic down turn
Investing Articles

2 top FTSE 100 shares I’d buy before the market rebounds!

Christopher Ruane identifies a pair of FTSE 100 shares that have both tumbled in the past year and that he…

Read more »

Business development to success and FTSE 100 250 350 growth concept.
Investing Articles

Here’s why the next bull market may have already begun

The UK stock market has taken the Bank of England's interest rate hike in its stride and green shoots suggest…

Read more »

Gold medal
Investing Articles

No contest! Here’s my stock of the week

An update from this company offered some relief from the economic gloom. It's this Fool's stock of the week.

Read more »

Cogs turning against each other
Investing Articles

Scottish Mortgage shares are back on the rise: is now the time to jump onboard?

Scottish Mortgage shares have risen over 25% in the past 30 days. This Fool takes a look at why and…

Read more »

Middle-aged white man wearing glasses, staring into space over the top of his laptop in a coffee shop
Investing Articles

Why do Lloyds shares seem so cheap?

Lloyds shares have been losing ground and now look cheap on some valuations. So why has our writer removed the…

Read more »

Investing Articles

How to invest in shares to help beat inflation

Soaring prices could well outstrip our investing returns this year. I think it's more important to find shares to beat…

Read more »