Sector Analysis: Entertain Your Portfolio

One area often overlooked by investors is entertainment. Though tied somewhat to consumer spending, entertainment stocks can provide diversification benefits. Plus, there are certain segments within the broad entertainment umbrella that are doing well despite the current economic backdrop.

One example is Netflix (NFLX). As many of you are aware, NFLX rents DVDs. Subscribers pay a monthly fee and can rent an unlimited number of DVDs. Plans range from $8.99 to $16.99 a month, which is considerably cheaper than adding premium channels such as HBO to the cable bill. (NetFlix does offer a $4.99 per month plan, but this limits rentals to two per month.) The cost is also less the price of two tickets to a movie theater in many metropolitan areas. For consumers looking to tighten their belts, renting from Netflix is an easy way to cut back on spending.

Last week, NFLX raised its first-quarter and full-year guidance. The online movie rental company anticipates between 8.16 million and 8.26 million subscribers this quarter, up from the previous forecast of 7.85 million to 8.05 million subscribers. Per share earnings are expected to be in a range of 15 cents to 22 cents per share, an approximate two-cent increase over previous guidance.

For the entire year, NFLX anticipates between 8.9 million and 9.5 million subscribers, 500,000 more than the company previously predicted. Full-year earnings should reach between $1.18 and $1.30 per share, up from $1.12 to $1.24.

Most of the covering brokerage analysts quickly raised their forecasts in response. The current consensus estimate of $1.24 is seven cents higher than the average forecast of a month ago, and 36 cents higher than the average forecast of two months ago. Notably, estimates for 2009 are higher as well.

Another area of the entertainment industry that seems to be holding up is gaming. Sales of video game software rose 11% in January to $610.6 million, according to NPD Group. Video gaming can provide hours of entertainment for a relatively cheap price - most games cost between $30 and $50. Hence, the reason that gaming sales are holding up despite the weaker economy.

The strength of sales within the gaming industry has not gone unnoticed. Within the past 30 days, brokerage analysts have raised their full year forecasts on both Activision (ATVI) and Take-Two Interactive (TTWO). ATVI developed the best-selling "Call of Duty 4". TTWO is set to release the next edition of its popular "Grand Theft Auto" series in late April.

Electronic Arts (ERTS), which makes some of the best selling sports-related video games, recently made a bid to acquire TTWO last month for $26 per share in cash. Take-Two Interactive quickly rejected the offer, opining that the price "substantially undervalues" its game franchises and customer base.

A new, higher bid is possible, but investing in a stock solely on merger speculation is risky. Even without a higher offer, the fact that earnings estimates are rising makes TTWO worthy of additional research.

Another gaming company with rising earnings estimates is Perfect World (PWRD). This Chinese online game developer exceeded expectations by nearly 50% last week.

Perfect World reported fourth-quarter profits of 34 cents per share [USD], besting analysts' projections by 11 cents. Total revenues surged 325.2% from a year prior to RMB258.4 million (equivalent to $35.4 million USD).

The company has several hits, including Perfect World II, Zhu Xian and Legend of Martial Arts. The popularity of these games drove the total number of active paying customers to 1.565 million, a 160% increase. PWRD is about to launch a large-scale beta test of "Hot Dance Party", an interactive casual 3D game, with the hopes of having another strong-seller in its portfolio.

Looking forward, PWRD expects to generate sequential quarterly revenue growth of 7% to 10% in the first quarter. One brokerage analyst raised his forecasts in response, pushing the first-quarter consensus estimate a penny higher to 29 cents per share.

More importantly, all three of the covering brokerage analysts revised their full-year projections. The new consensus earnings estimate calls for the company to earn $1.47 USD this year, a 10-cent increase from the average forecast of a month ago.

Charles Rotblut, CFA, is the senior market analyst for Zacks.com.

Full Disclosure: Author owns shares of (NTDOY.PK).

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