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 - Get Report) 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 - Get Report) 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.

Although EA had one down earnings year during the last console transition, this time around it will have at least two. Activision, which has prided itself on consistently posting revenue growth over the last 13 years -- through two previous console transitions -- is now predicting sales will be essentially flat this fiscal year with last year and will fall more than 20% next year. THQ, which had been predicting a billion dollars in sales in fiscal 2007, is now cautioning investors that its sales will fall shy of that magic number.

Despite the disappointing news, investors largely have kept faith with the companies' stocks. While shares of THQ and Activision have declined since they reported, estimates of their fiscal 2007 earnings have fallen far more sharply than their stocks. And shares of EA are actually up more than 1% since it reported earnings last Thursday.

Notes from sell-side analysts that followed the earnings reports generally pointed to the improvement in earnings expected in 2008 or beyond, suggesting that investors look to the future. Making the case for EA, one unnamed buy-side analyst, whose firm owns the shares, argues that the stock should at a minimum appreciate 50% over the next four years.

"That's what I consider a more conservative scenario," the analyst says. "Where else can I feel confident that I can get a 50% return over the next four years?"

But other investors are far less confident in that kind of return from EA -- or the rest of the sector.

Regardless of the longer-term outlook, as these companies work through the transition, their stocks are likely to be flat. Indeed, for most of the major publishers, that's been a best-case scenario for the past year. Activision is up just 1% over that time frame, while EA is down 21%, Take-Two Interactive ( TTWO - Get Report) has plunged 40% and Atari ( ATAR) is off a whopping 68%.

"There's an opportunity cost to continuing to hold the video-game publishers' stocks as the cycle transition draws out," says Tony Ursillo, a buy-side analyst with Loomis Sayles. "You could have been in other names that are working outside tech or in tech." Ursillo's firm has long positions in EA and Activision.

But Ursillo and others even question the longer-term bull case. Sales may not grow as quickly as the faithful expect, suggests Joe Spiegel, managing member of Dalek Capital, a hedge fund. In the near term, there's been a lot of buzz about the Xbox 360, but shipments of the game machine have been disappointing, putting a lid on the number of games anyone can sell for it, he notes.

Although bulls point to revenue from ads sold within games, an increase in online games, and price increases on next-generation titles, Spiegel says all of those could prove more hype than reality. Consumers could well reject ads in games; few online games have drawn a mass audience; and consumers have generally been price-sensitive, putting into question each of those developments.

"People are getting excited about certain ideas that really they shouldn't be," says Spiegel, who is long shares of, and short put options on, Take-Two, but who has no other positions in the sector.

But it's not just future sales that could disappoint. Development costs of next-generation games are ballooning, Ursillo and other analysts note. So, too, are costs related to licensing sports teams and movie content. As a result, game publishers' earnings could end up growing more slowly than bulls believe. And that could have big implications for the future value of their stocks.

"If you don't have a very bullish-case scenario, you're holding out for total appreciation that isn't going to measure up," says Ursillo.

That's not to say that Ursillo or the other skeptics are blackballing the sector. "I'm willing to own them at lower prices," he says. "I just don't think the upside justifies buying them today."