MENU

This top growth share is really performing. But is all the good news priced in?

The fast-growing video games industry has become hugely popular with investors in recent years. One clear beneficiary of this has been services company Keywords Studios (LSE: KWS).

Between 2016 and 2018, shares in the Dublin-base business almost ten-bagged in value — further evidence that finding promising stocks at the smaller end of the market spectrum can seriously grow your wealth over a short period of time. 

Since last September, however, the value of the company has dropped significantly. Despite a small bounce in recent weeks, the share price is still 35% down from its peak. 

As far as I can tell, most of this fall can be attributed to jittery investors jettisoning highly-rated growth stocks from their portfolios and little to do with how the company is performing.

Indeed, today’s full-year results revealed that Keywords continues to do very well. 

Positive outlook

Revenue jumped 66% to a little under €251m in 2018 as the company increased its market share and added new services such as marketing, music management, and predictive analytics. Adjusted pre-tax profit rose by almost the same percentage to €37.9m.

Further good news included a rise in return on capital employed (to a very solid 19.4%) and a 10% increase to the total dividend (to 1.61p).

The outlook was equally positive. 

Keywords stated that it had seen an “encouraging” start to 2019 (with trading in Q1 in line with expectations) and that it has achieved “significant new business gains” which included its first contract wins relating to game streaming.  

As far as the latter is concerned, CEO Andrew Day commented that “the likely increase in demand for content driven by the arrival of games subscription and streaming services from new entrants such as Apple and Google” bodes very well for the company.

Whether now is the right time to buy the stock is, however, less clear.

For one thing, the fairly apathetic reaction to today’s impressive figures implies that recent performance was already priced in. Before markets opened this morning, Keywords shares traded on a high valuation of 28 times forecast earnings.

It’s also worth noting that interest from short sellers has increased.

True, the 3.5% of stock currently being shorted isn’t as much as other growth-focused companies like IQE (7.9%), but it does appear that some are beginning to question whether the acquisition-led strategy the company pursues — and which shows no sign of slowing — could come back to haunt it later down the line.  

Driving profits higher

Of course, there are other options out there for investors looking to tap into the gaming industry as a way to increase their capital.

Developer and publisher Codemasters (LSE: CDM) released a cracking update last week. As a result of strong trading in H2, the small-cap is now expected to report full-year revenues of around £71m.

Even more encouragingly, adjusted earnings are now likely to be somewhere in the region of £18.5m — more than analysts were expecting — thanks in part to the release of driving game DiRT Rally 2.0 in February.

While Keywords offers more earnings diversification (in the sense that its success isn’t reliant on the popularity of a single game it works on), shares in Codemasters also trade on a lower valuation of 18 times forecast earnings.

Assuming the latter is able to grow profits as expected, one might reasonably argue that it represents a better buy at the current time. 

Powered By Profits

In our complimentary report “A Top Growth Share From The Motley Fool”, this analyst believes there’s still plenty of room to run for this industry leader as it expands beyond Europe into the USA and Asia despite its shares soaring by more than 500% over the past 5 years! Simply click here for your free copy of this guide.

Paul Summers has no position in any of the shares mentioned. 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.