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Electronic Arts: Shock Therapy

Earnings have fallen two straight years at Electronic Arts (ERTS), and the company expects things to get worse. But that hasn't shaken the faith of many long-term holders -- nor dissuaded others from buying in.

EA's shares fell as much as 14% on Thursday after the video-game software provider offered an extremely disappointing outlook that called for earnings as low as one-third what analysts were expecting.

Despite the slide, many analysts and longer-term holders are willing to continue giving the company the benefit of the doubt and chalk up the company's recent problems to transition troubles as the industry moves to a new generation of hardware. As the largest video game publisher, EA stands to benefit as a mass market starts to develop in coming years for new game consoles and the software for them, bulls say.

"Despite where we are in the cycle, the fundamentals are strong," says Darren Chervitz, a research analyst at Jacob Asset Management. "Over the next couple of years, I think video-game-publisher stocks are good investments." Chervitz' firm is long EA and THQ (THQI).

Bulls such as Chervitz back up their case with a number of arguments. First and foremost, they note, are overall trends in media usage. Consumers are spending more time playing games or surfing the Internet than watching television or reading newspapers, they note. Meanwhile, while games continue to have their stronghold in the teen and pre-teen set, the average game player continues to get older as the overall demographic appeal of video games has broadened, they say. The new consoles, which have robust graphics engines and online capabilities, should help extend those trends, they say.

"The gaming experience is going to be significantly better on the new consoles ," says Kyle Flynn, an analyst at investment firm TCW, which is long EA. "The big picture is the trends haven't changed. People are going to continue playing these games. As they get more intense and rich, they will appeal to a broader audience."

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