Investing in Video Games Part 2: Microsoft Is A Solid Investment But Income Has Slowed

Welcome to part 2 of Investing In Video Games . In part 1 we covered the 5 basic investment rules I use in my own investment company. Here is a quick review of the rules:

Investment Rules

  1. If you don't get it, research. If you still don't get it, avoid.
  2. Success is inflation plus 5%.
  3. The investment world is a playground for big money. The odds are not on your side.
  4. Learn how to hedge.
  5. Never trust a stranger for investment advice (that includes myself if you don't know me).

Okay so how do you start investing? You need to open an account with a stock broker.
Which broker is the best? It depends on the amount of money you plan to invest.

Broker Account Checklist

  1. Lowest stock trade commission.
  2. Lowest options fee.
  3. Low margin rates.

You will need options even if you dont know what they are yet. They are a great tool for hedging. Other things you might want to consider are bond & FOREX fees however there are ways to invest in bonds (and treasuries and futures) without the need to buy them directly (something I definitely dont recommend doing for various reasons), and you will not need to do any money exchange to buy most commonly traded foreign stocks nor do I recommend playing the FOREX game for investing purposes since money itself is not a business any more than gold or collectibles (again these are playgrounds for the ultra rich and not good for most folks). Lastly, you will never trade in mutual funds because if you learn how to invest properly, it will render them completely useless and waste of money.

The lowest fees will depend on how much money you are investing.

OptionsHouse: For folks just starting out, I strongly recommend OptionsHouse because their stock trade fees is the lowest, and their options fees are the lowest by a huge stretch. Further, Optionshouse allows you to open a fictitious virtual trading account which you can use as a playground for strategies, and learning purposes. In the virtual account, you can assign yourself money, trade anything you want, and monitor your performance for years on end if you so choose. The only place that optionshouse is not the cheapest is margin rates however you are not going to use margins as a newbie with little money invested.

Interactive Brokers: You generally dont need to worry about margins until you have over $100k in your account and for those with $100k or more already, I strongly recommend Interactive Brokers because their margin rates are far below anyone else which will allow you to use margins as a tool rather than for short term gambling. Once you have $100k or more, each trade will be large enough that trading fees will have less of an impact and the only thing that will make a dent is margin fees should you decide to use them.

Other brokers I have worked with in the past include E*Trade, Scottrade, TradeKing, & Lightspeed Trader. The big problem with all these brokers is longevity. For instance, TradeKing looks comparable to Optionshouse and might actually be cheaper for very small accounts however their option fees do not scale well as your account grows. Eventually you will be paying a lot more for options at TradeKing than Optionshouse due to their higher per contract fee. Further, all of these guys have high margin fees so they are not appropriate for bigger investors who wish to utilize margins. Some of these brokers will try to sell you on their research tools... do not fall for it. All the tools you need are available for free on various websites. In fact, the freely available websites like Google Finance, Yahoo Finance, Morningstar, Y-Charts, & QuantumOnline are much better at displaying data in meaningful ways, so you will probably never use the broker sites for research anyway. Some will try to pull you in with promo offers; to that I say crunch the numbers but ultimately look at the long term since moving accounts takes time and can be tedious. I believe OptionsHouse offers comparable free stuff anyway and bigger ($100k plus) investors wont care for promos so no matter how you slice it, as of today (9/2/2014), Optionshouse and Interactive Brokers are the best choices available. Lastly, the trading style I will be covering does not require frequent trading thus limited time trading discounts are not going to be very useful.

After you open an account with your choice of broker, you will need to deposit money into that account. After that you will be ready to make trades. Here are some more general tips that you should consider when managing your investments:

The Cheapskate Rule: Never make a trade worth less than $1,000.
The reason for this is to minimize trading fees. Since each trade has a minimum commission, you want to avoid making a lot of small trades. Keep your trading blocks to a minimum of $1,000 each and avoid falling into the day trading like the plague (It really is a mathematically "zero sum" game minus fees so don't fall into it).

30% Margin Rule: Never borrow more than 30% of your account value.
This is a general rule of thumb for intermediate investors. Note again, that you really should not be playing with margins until you have at least $100k in your account. The reason for this is because the returns you generate from the margin will be too small to matter. For instance, lets assume someone with just $10,000 invested uses a margin of 30% to buy Nintendo stock. Now lets assume for giggles, that Nintendo goes up 25% on the year. The margin profit for this trade is only 25% of 30% of $10,000 or about $10,000*.3*.25 = $750... you also need to subtract the margin rate from that number but as you can see, the gains are not all that great and we are assuming your stocks goes up. Bottom line, it will not make you rich so why gamble? Compare this to the guy who has $100k and you will note that they make $7,500 a year which is very significant to many people. I know that you can make an argument that the risks are the same however they really are not. A person who is able to save $100k for investing is in a much more stable position in life than someone who is just starting out. Chances are, the $100k investor has money stashed away elsewhere and probably has a retirement fund and other savings to weather the storm of bad years whereas the person with $10k probably has little to fall back on.

Hedge/Margin Rule: You can use any amount of margin if your portfolio yields more than the margin rates and you are fully hedged on your position/s.
Note that this is a very advanced rule and should only be employed by those who are already very familiar with use of options as a hedging tool. Do not do this as a means to gamble. Many people lost their shirts gambling with margins and some even committed suicide. Remember, margins are a tool but a very destructive tool in the wrong hands. We will cover options hedging in a later article.

That's enough boring stuff for today. I made a list of topics already covered and the future topics:

  1. Part 1: Basic Investing Rules
  2. Part 2: How to Select a Broker Account
  3. Part 3: Intro to Hedging & Options
  4. Part 4: Best Websites for Researching Investments
  5. Part 5: Risks Associated With Video Game Stocks
  6. Part 6: tbd

At some point I will create a page with a summary of all the stocks covered. Lets look another game (related) company.

Microsoft Corporation

GTan Rating: 3/5 (neutral)
Morningstar Rating: 3 star (out of 5)
S&P Capital IQ Rating: 3 star (out of 5)
Reuters Rating: Positive
Smart Consensus Rating: Buy

Share Price: $45.09
Valuation: $374.34 billion
Cash on hand: $84.94 billion
Debt: $23.22 billion
Yearly Revenue: $86.83 billion
Yearly Net Profit: $22.07 billion
Earning Per Share: $2.63
Price/Earnings: 17.14
Dividend Yield: 2.48%
Dividend/Share: $0.28
3 Year Performance: Slowly Shrinking (-1.57% per year)
5 Year Performance: Fast Growth (8.67% per year)
10 Year Performance: Very Fast Growth (10.45% per year)
Earning Consistency: Fair Reliability
Risk Level: Very Low
Total Executive Compensation (2012): $25.0m (0.12% of company profit)
Total Executive Compensation (2013): $38.5m (0.17% of company profit)

Say what you will about Microsoft, but at the end of the day they are a good business. Their console might not win any console sales wars, and their tablets might not outsell the Neo Geo but their software remains an unstoppable force. With a Windows license sold with almost every PC & laptop worldwide, its very hard to avoid Microsoft even if you want to (believe me I tried). Further, businesses are not going to switch software companies over a few hundred dollars per workstation which is minuscule compared to other costs such as training and support. We can argue all night about how trivial it is to switch to Linux and LibreOffice but the fact is that the average human is so dumb that even such a trivial switch will result in countless hours of them fumbling around looking for a button or asking for tech support. At the end of the day, the cost to switch will outweigh the price of simply sticking to Microsoft products. Of course, their Windows 8 changes were extremely questionable but it looks like it has had little resistance at the corporate level. If there ever were an opportunity to switch to Linux it would have been with Windows 8. Its true that the popularity of Apple has had an impact on the consumer level but it did not make a dent at corporate or enterprise. The bigger threat on the consumer scale is people moving to Apple & Android tablets but at this time such devices remain less than useless for productivity purposes due to small screen, slow processors, and minimal storage. People still need a PC of some sort for heavy duty work even if they prefer a pad for light uses. Therefore, PC's are still needed and Microsoft will continue to capitalize.

On the video game front, Microsoft has historically been profitable on their console hardware albeit the margins were low compared to software and software licenses. I do not see the consoles competing with Windows and Office profit wise, but I can see them climbing to about 10% of total net profit if they take gaming seriously which they have not historically (or so it seems). Microsoft definitely has a schizophrenic opinion about their own gaming division with some high level management stating outright that they should be eliminated or sold off... then again that manager was also the same guy who destroyed Nokia and is considered one of the worst CEO's in modern history so we should not take his word too seriously. The XBox brand is strong but it needs someone with intelligence to make wiser decisions to allow it to take off. For instance, I can pretty much guarantee a doubling of net income on video game profit in 3-5 years by simply making all their games cross compatible with Windows (though its probably too late for this generation). I would eliminate the XBox hardware manufacturing entirely and open the console up to any manufacturer that is willing to manufacture it as long as they follow the standards put forth by Microsoft. This will insure that all the hardware behaves the same way since they must follow the same recipe to qualify. At the same time, the games will remain compatible with Windows albeit no support (from Microsoft specifically) should be provided for gaming on a non-XBox rated machine. All of a sudden, the install base for their games would increase 1000 fold worldwide and game sales would skyrocket as a result. Basically, they would get instant install base in every country that currently does not favor the XBox like Japan and much of Europe. Even if just 0.1% of PC owners buy an XBox game, that will triple XBox software revenue and easily double XBox software net earnings. The console would also be unstoppable in terms of performance because a new version could be engineered every year by Microsoft and they would not need to worry about the hardware manufacturing at all. Manufacturers will like it because it will bring back "PC" revenue which has been dwindling thanks to Pads. On top of all of that, this move would increase dependency of Windows on the PC, of which Linux has made significant advancements. The problem with Microsoft is that they did it all backwards. Instead of working around what people already liked, they decided to force everyone to change to something that looks like their XBox product. This reflected in their Windows 8 release and most people hated (and still hate) the Metro (Xbox style) desktop.

I went on a tangent there, but bottom line is that Microsoft has potential to grow gaming revenue if they just wise up a bit. Money is in software, not hardware. The power of Windows and Office is familiarity and nothing else so why not leverage it? They need to extend that familiarity to the console not make something new just for the sake of looking hip. With a new CEO at the helm it is entirely possible that Microsoft can start doing things better but it remains to be seen how things will play out. In the meantime, I have to rate them as neutral in light of their valuation (17 P/E) and recent shrinking earning performance. They really need to pick up the earnings a bit for me to consider them a buy at current prices however they are a strong company and their 5 & 10 year performance was excellent. They also offer a nice dividend and have consistently added value to shareholders through share buybacks. On the financial front, they have tons of cash on hand and very little debt in comparison so they are in good shape to grow.

- Stagnant and/or shrinking net earning (margins are shrinking)
+ Revenue is skyrocketing (if they can fix margins this will result in huge gains)
+ Good Combination of Dividends & Share Buybacks

I personally do not hold any MSFT stock. Not because it is a bad investment but because I found better places to invest. Unfortunately, none of the better options are game stocks so if you are only interested in game related stocks, then MSFT might be a good pick. Certainly it is a safe long term bet.

Thank you for reading part 2. See you in article #3.

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