The Fundamental Case For Nintendo

Japan-based Nintendo (NTDOY.PK) is the world's third-largest video game console maker, trailing only Sony and Microsoft. The company was among the pioneers of the industry, gaining notoriety in the late-1980s and 1990s with its original Nintendo console.

The company also produces a portfolio of popular games, including Metroid, The Legend of Zelda, and Super Mario Brothers. These longstanding favorites were developed in-house and have been around for nearly two decades.

Competitive Advantages
Nintendo benefits from its strong reputation and brand recognition with slightly older gamers. Most were introduced to the company back in the 1980s and are familiar with the company's popular software titles and on-screen characters. These consumers are intensely loyal to the brand. In addition, while there is certainly some overlap, this is a slightly different niche than that targeted by Sony and Microsoft.

We also see the new Wii console's price, availability and unique design as key advantages for Nintendo over the next few years. Specifically, the PS3 retails for $499 to $599, depending on which version of the system you purchase -- and Sony is losing money even at that price. Meanwhile, the Nintendo Wii costs about $250 and is made out of more generic, easier-to-source components.

As a result, the Wii is both cheaper and easier to find than the PS3. While both consoles have been selling well, the Wii has been exceeding analysts' expectations by a wider margin. In short: the console cycle for the Wii is ramping up faster than for the PS3. And while price is rarely a sustainable competitive advantage longer term, in this case it's giving Nintendo a leg-up in the sweet spot of the console cycle.

On the design front, the Wii incorporates a highly innovative controller that is sensitive to hand motions made by the user. This allows users to play games like golf and tennis on the machine more realistically. That feature has proven popular and has opened up a line of games unique to the Wii. While Sony could design a similar controller, it would take well over a year to develop the hardware and games compatible with the new controllers.

Growth Drivers
The primary growth driver for Nintendo over the next few years will be the Wii. Supplies are tight at the moment, but availability of the console is already improving somewhat. With millions of new Wii systems being shipped all over the world, Nintendo is essentially opening up its software to a wider audience.

All those new consoles represent an opportunity for the company to start selling even more of its iconic software titles. Since many of the most popular titles and characters are unique to Nintendo, the firm gets to keep all of those revenues.

Valuation and Outlook
Nintendo trades at about 32 times forward earnings. While no analysts publish five-year growth expectations, earnings are expected to soar over the next two years, which makes that multiple look much more reasonable. And with Wii sales ramping up faster than expected, Nintendo has a good shot at beating Wall Street's expectations over the next few years.