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Video Games: Worth the Wait?

Investing in video-game stocks is starting to come down to a matter of faith.

After a crummy holiday season, game publishers are predicting more tough times ahead. What was supposed to be a relatively smooth changeover to new game hardware is turning into a rougher transition than was seen in past cycles.

But for true believers, none of that really matters. What matters is that two or three or four years from now, the industry likely will be booming again -- and so, too, should the stocks of game makers.

But some investors are beginning to wonder whether that faith is misplaced. While they don't doubt the sector has a bright future, they do question the wisdom of investing at current levels. In their view, other sectors are likely to give better returns in the short run -- and the upside on video-game stocks may not be as good as the faithful believe.

"Basically, what's going on is people are buying these stocks blindly for the next console cycle," says one portfolio manager who keeps an eye on the video-game sector, but has no positions in it. "They're going to be disappointed at some point."

One would have thought some of that would have been tested over the past week. Since last Thursday, Electronic Arts (ERTS), Activision (ATVI) and THQ (THQI) all reported earnings significantly lower than a year earlier.

In the case of EA and Activision , earnings were even below the lowered expectations of analysts, who had cut forecasts following earnings warnings from both companies.

But beyond the disappointing numbers, the reports were also gloomy for what they indicated about the ongoing console transition, which officially began last fall when Microsoft (MSFT) launched its Xbox 360 machine. While past transitions have been marked by slumping industry sales and rising costs, the industry had hoped things would be better this time.

Instead, things could be worse.

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