Who's Winning the Console Wars

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THQ raised its earnings and sales outlook for its fiscal third quarter (ended Dec. 31) and for fiscal year 2007 on Jan. 11 (sending its stock to a 52-week high). Do you see more good news for the sector?

Yes, we see good news for the sector. Last year, the industry faced a lull because a lot of gamers were postponing game purchases in anticipation of the new consoles. The new consoles—the PS3 and Wii—came out in November. As the installed base grows, you should see a positive effect on the stocks.

I [advise] caution because the stocks have made a substantial runup since the summer of 2006 and valuations have gotten lofty. I think the release schedule of video game hit titles and lineups for future titles will help the shares moving forward. In the meantime, when there's a small user base, there's a slower release schedule because it costs money to develop the games and it also depends on which console the games are developed for.

Where does each company stand with releasing titles?

Electronic Arts (ERTS) has a big exposure to PS3. Now that PS3 has had subpar unit sales results, that might affect EA stock in the near term. It also affects the timing of the release of games—usually they want to release games when the console install base gets larger.

For THQ, I believe they did well because of releases for the Wii. They also have a strong market share lead for the younger audience. THQ makes Cars and WWE SmackDown vs. Raw 2007—they both did well, which is why they upped their outlook.

Activision's franchises include Tony Hawk's Project 8 for PS3 and Xbox 360 and Tony Hawk's Downhill Jam for the Wii. Call of Duty 3 is for all consoles, and Guitar Hero 2 is out only for PS2 but they will probably release it for other consoles because of its success on PS2.

What are the hot games coming out this year?

One of the biggest games this year is Take-Two Interactive's (TTWO) Grand Theft Auto IV. Although details are under wraps, it should be out on multiple consoles in late 2007.

The other game is Halo 3, which Microsoft produces—that's exclusively for the Xbox 360, and should help sales of that console.

There is a huge following for those two games.

What are your recommendations on the stocks?

I have a buy on Activision because they have a really strong library of hit games.

I have a hold on Electronic Arts. They also have a strong library of games, but their valuation is relatively high.

I also have a hold on THQ, because I think their lineup for 2008 looks weaker compared with their peers.

And I have a sell on Take-Two Interactive because I think they have the least hit titles among their peers. Also, the stock's valuations are equivalent to some of their peers that have more hit titles.