Video Gaming Sector Keeps Defying the Slowdown By Michael Comeau Breakout Stocks Portfolio Manager 4/16/2008 9:41 AM EDT

The slowing economy has led consumers to cut back sharply on discretionary spending. But they still appear ready to pony up for the latest video games. The sector has appeared relatively immune to the broader tech slowdown.

On Thursday night, we should get further confirmation of that trend, as market-research firm NPD will report March retail sales figures for the industry. Here's what to look for.

The first focus for investors will be the growth in software sales. Given the blockbuster Nintendo Wii release Super Smash Bros.: Brawl, analysts are generally looking for growth of around 40%. Other key software releases during the month include Electronic Arts' (ERTS) Army of Two, and France-based Ubisoft's Rainbow Six: Vegas 2. However, I would not be surprised to see software sales growth exceed 50% or even 60%, as analysts have tended to underestimate the strength of key releases. In addition, follow-through of hits from past months, notably sales of Activision's (ATVI) Call of Duty 4, should remain strong.

As far as individual titles' impact on stocks, I am eagerly awaiting sales of THQ's (THQI) Frontlines: Fuel of War, which was release in late February and got off to a decent start at retail. However, Army of Two and Rainbow Six: Vegas 2 probably hurt Frontlines' follow-through in March, and a weak performance from Frontlines could result in THQ missing its guidance for the fiscal fourth quarter.

Next-generation hardware unit sales should stay on the upswing as well, especially for Sony's (SNE) PlayStation 3, ahead of the release of Take-Two Interactive's (TTWO) Grand Theft Auto IVnext month. In fact, I expect the PlayStation 3 to handily outsell the Microsoft (MSFT) Xbox 360. For investors in software stocks such as Electronic Arts and Activision, the ideal scenario in this battle is to see the PlayStation 3 pick up as much steam as possible. This is because the software attach rate on PlayStation 3 consoles should increase substantially this year due to a dramatically improved game lineup.

And, of course, the Wii should continue its impressive momentum given chronic shortages at retail, which have been driven by significant interest from mainstream consumers and nontraditional gamers. Plus, Super Smash Bros.: Brawl is a true mega-franchise to Nintendo fiends and has probably tipped the supply-demand imbalance even further for the foreseeable future.

As far as the stocks go, I continue to like Activision due to the dominant game lineup that will come out of the merger with Vivendi Games. GameStop (GME) remains a top pick in our Breakout Stocks newsletter. I expect the stock to rally in reaction to blockbuster industry sales numbers over the next few months. I'm still not a fan of Electronic Arts, THQ, or Midway Games (MWY) , and I believe that profit-taking is imperative with Take-Two, even with the potential for Electronic Arts to raise its bid above $26 a share.

Readers should note that in the near-term, there's more than Grand Theft Auto IV on the way to keep the industry humming. Over the next few months, we'll see the release of Metal Gear Solid 4, Mario Kart Wii, Gran Turismo 5: Prologue, Wii Fit, Lego Indiana Jones, Haze, Ninja Gaiden 2, and Rock Band for the Wii.

And later in the year, the momentum should keep pumping, courtesy of highly awaited titles such as Star Wars: The Force Unleashed, World of Warcraft: Wrath of the Lich King, Too Human, Soul Caliber IV, Prototype, Resistance: Fall of Man 2, Killzone 2 and Gears of War 2. I'm leaving some names out, but the fact that I was forced to cut the list down is bullish in itself.

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In keeping with TSC's editorial policy, Michael Comeau doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. Comeau is a research analyst at TheStreet.com. In this role he performs stock analysis for TheStreet.com Breakout Stocks, and is also a regular contributor to RealMoney.com. Prior to his arrival at TSC in June 2004, Comeau worked as a Consultant to Toyota Motor North America, performing in-depth research on automotive industry issues, primarily in the areas of alternative engine technologies, competitive analysis and macroeconomics. His primary market interests include consumer technology, specialty retail, and small-caps. Comeau received a bachelor's degree in Finance from Brooklyn College, and has completed Level 1 of the CFA program.. He appreciates your feedback; click here to send him an email.

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