Down over 40% since June, is this former market darling now a bargain?

This growth stock once rewarded investors handsomely. Paul Summers asks whether its recent poor form will reverse.

| 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.

In its five years as a listed company, video games developer Frontier Development’s (LSE: FDEV) stock has moved from 161p to trade as high as 1825p. Assuming they were sufficiently invested and didn’t sell until roughly three months ago, some of the company’s early owners must surely be well on their way to achieving financial independence.

More recently, however, this momentum has completely reversed, leaving Frontier’s stock trading 42% lower by the close of play yesterday. Based on today’s full-year figures, this drop isn’t entirely unexpected. 

Despite the “ongoing success” of its first two franchises (Elite Dangerous and Planet Coaster), total revenue dipped almost 9% to £34.2m in the year to the end of May. A combination of investment and a lack of a new franchise launch in the year meant that earnings before interest, tax, depreciation and amortisation (EBITDA) also fell — by 26% to £9.4m. 

Nevertheless, an eventual return to form for the share price looks likely.

The launch of its Jurassic World Evolution franchise in June appears to have gone extremely well. Cumulative sales passed the one million mark only five weeks after the digital launch, allowing Frontier to register “a record trading performance during the period from the year end.” As such, it’s perhaps no surprise that management is “comfortable” with analyst revenue forecasts of between £75m and £88m for the 2018/19 financial year.   

Longer-term, CEO David Braben remains bullish. He believes Frontier’s three franchises leave it “very well positioned” in the industry. A fourth is expected to be released in FY20 and, in keeping with Frontier’s ambition to “create a multi-franchise success story“, two additional titles are also in “earlier stages of development.”  This, coupled with its growing relationship with Chinese entertainment giant Tencent following the latter’s strategic investment in 2017, should ultimately help the stock recapture its former spark.

Assuming all goes to plan, a forward P/E of ‘just’ 24 for 2019/20 could make the shares something of a bargain today.

Reassuringly expensive

Thanks to its lack of dependence on the success of just a few titles, however, my preference in this industry remains diversified gaming services provider Keywords Studios (LSE: KWS) — a stock I’ve owned for two years now. Over this time period, the company has more than quadrupled in value as the market has seriously warmed to its growth strategy.

Normally a seemingly never-ending acquisition spree would put fear into the hearts of investors. Taking into account the fragmented industry in which it operates, however, it continues to make a lot of sense for a business like Keywords. 

The latest addition to its estate is Gobo (composed of Studio Gobo and Electric Square). Purchased for a total consideration of up to £26m, it provides services to video game publishers and developers around the globe. Revenue grew from £6.2m in FY17 to £11.6m in the 12 months to the end of July.

According to Keywords, this acquisition — expected to be earnings-enhancing in the first year — “adds considerable expertise and scale” to its game development business. 

A current valuation of 45 times expected earnings will still be too high for many investors. But this isn’t to say that Keyword’s stock is necessarily overpriced. Indeed, some companies continue to motor ahead despite having a perpetually high price tag. In my mind, Keywords will continue to occupy this group. 

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 recommended Keywords Studios. 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

Warren Buffett at a Berkshire Hathaway AGM
Investing Articles

UK shares are cheap! So why is Warren Buffett ignoring them and should you too?

Many British shares are trading cheaply and pay dividends. This is normally the hunting ground for Warren Buffett, yet he's…

Read more »

Passive income text with pin graph chart on business table
Investing Articles

How I’ve increased my passive income by 600%

Finding the right opportunities can bring spectacular results. Here’s how our author has managed to increase his monthly passive income…

Read more »

Blue NIO sports car in Oslo showroom
Investing Articles

Could lithium shares make my Stocks and Shares ISA a goldmine?

Our writer is considering buying lithium shares for his Stocks and Shares ISA. Here, he outlines the decision process he…

Read more »

British Pennies on a Pound Note
Investing Articles

Is now a great time to start buying penny shares?

Are stock markets set for a rebound? If they are, there are plenty of penny shares around that might be…

Read more »

pensive bearded business man sitting on chair looking out of the window
Investing Articles

Can the Lloyds dividend survive a recession?

The Lloyds dividend has been growing strongly. But its history is more alarming. Christopher Ruane explains why he sold his…

Read more »

Electric cars charging in station
Investing Articles

I’m buying this under-the-radar income stock with explosive growth potential

Our author thinks he’s found a winning lithium stock that’s flying under the radar. It’s a steady income stock that…

Read more »

Playful senior couple in aprons dancing and smiling while preparing healthy dinner at home
Investing Articles

Are Rolls-Royce shares finally about to climb?

Rolls-Royce shares have been falling again. But I can't see that much has changed, and the full-year outlook still appears…

Read more »

Serious puzzled businessman looking at laptop
Investing Articles

When should I sell my Scottish Mortgage shares?

Buying some Scottish Mortgage shares was an easy decision for me. But I've never been any good at knowing when…

Read more »