Next Generation's Software Growing Pains

With three new game machines expected in the next year -- and two new handheld game devices already on the market -- this is a great time to be a gamer.

What remains to be seen is whether it will be a great time to be a game maker -- or an investor in such companies.

The launch of Microsoft's(MSFT Quote) Xbox 360 this week will inaugurate the latest console cycle, a ritual that begins every five years or so. Each successive cycle has eventually led to bigger sales, bigger profits, and surging share prices for the top players.

(TheStreet.com this week also looked at how Microsoft's rivals will cope with the ballyhooed rollout; how far Microsoft will make it into consumers' living rooms; and what a game is worth.)

But in the short term, the transition to new machines typically means trying times for makers of game software: slowing sales, rising costs, and stumbling stocks. Worse yet, the transition can also be the beginning of the end for weaker companies that just can't afford to keep up.

For investors, then, making money off the transition becomes a game of timing and educated stock-picking.

Count Joe Spiegel, a hedge fund manager at Dalek Capital, among those who believe it's too early to invest in the game software companies based on hope about the next-generation consoles. Sony(SNE Quote) and Nintendo won't come out with their new machines until next year and Microsoft will sell only a limited number -- likely fewer than 2 million -- this holiday season. That's too small a base of users to really boost software companies' results, or their stock prices, he argues.

"People may be getting too excited too soon," he says. "If you're looking at making investments based on next-generation for results this year, you're making a mistake. You're being blinded by hype."

But other investors say the time to jump on the next-generation train is either now or soon approaching. Even if sales of next-generation games won't be meaningful until sometime next year or beyond, stock prices will likely soon reflect expectations of those sales, if they haven't already, says one fund manager, who asked not to be named.