If Pong comes to mind when you think of video games, then you may be out of touch with the powerhouse that the video game industry has become. Once the exclusive realm of teenage boys and male college students, video games are breaking through barriers to become entertainment for the whole family; they are even recommended as activity for seniors. In this article, we'll look at ways to invest in this winning industry. (To learn more about investing in the retail sector, see Analyzing Retail Stocks and Choosing The Winners In The Click-And-Mortar Game.)

Challenging Consoles
Consoles, the hardware and software that games run on, are the first place to look for video game industry exposure. Sony (NYSE:SNE), Nintendo (OTC:NTDOY), and Microsoft (Nasdaq:MSFT) are the big three console makers. The companies' different histories have influenced their consoles and their business strategies.

  • Sony
    Sony entered the market in 1994 with the first in its PlayStation franchise, and Sony's game division is just one part of the electronics giant. For this reason, Sony's systems have always had capabilities beyond playing video games. PlayStations play CDs, DVDs and Sony's Blu-ray discs. Sony's initial success helped edge Sega out of the console market in the 1990s and even put Nintendo on the ropes. Sony lost some ground to Nintendo with Nintendo's introduction of the interactive Wii gaming system in 2006.

  • Microsoft
    Microsoft's Xbox was born out of the demise of Sega's Dreamcast in 2001. Microsoft teamed up with Sega for work on the Dreamcast and, although the system was destined to be Sega's last, it gave Microsoft a taste for the industry. By launching the Xbox, Microsoft found a way to turn the threat of video game competition with the personal computers market to its advantage. Through the Xbox franchise, Microsoft has interests in console gaming in addition to PC gaming. The Xbox series benefits from Microsoft's computer background and features impressive software as well as hardware.

  • Nintendo
    Established in 1889 and eventually becoming a video game company in 1975, Nintendo is the oldest of the three companies and the only one that is purely a video game company. It started as a playing card company in Kyoto, Japan. Its first cartridge system, the NES, which was released in 1985, featured the best-selling video game of all time, Super Mario Bros. Since then, Nintendo has created a solid franchise on the back of exclusive series like The Legend of Zelda, Mario, Metroid and Donkey Kong games. According to VGChartz, as of November, 2009, the Wii led sales for its generation of game consoles (not including haldheld consoles).

Pwn'ing the L33t
"Pwning the L33t", or "power-owning the elite" in gamer speech, makes all the difference in this fast-paced market. The problem with investing in Sony and Microsoft in order to get at the video game industry is that there are many non-video game divisions mixed into the stock price. Exceptional sales of their consoles won't necessarily help the bottom line if sales in other divisions lag.

Nintendo, however, can be bought through depository receipts, and its revenues and price are directly tied to its fortunes in the video game market. Unless one of the other consoles is spun off as a separate entity, Nintendo depository receipts are the only sure way to gain direct exposure to the industry through console makers. (Learn more about investing locally in foreign companies in What Are Depository Receipts?)

The Developers
Video game consoles are usually sold at close to cost, or even at a loss, following the razor-razorblade model. The real bread and butter for console producers is revenue from games, and this is also where the game developers come into the picture.

Investing in game developers is like investing in movie companies or pharmaceuticals. The share prices of developers swing according to what's in the pipeline. As the cost of developing games has increased, many small developers have been bought up by bigger companies or private equity firms in order to access more capital. Smaller developers are generally privately held, but larger developers like Electronic Arts (Nasdaq:ERTS), Take-Two Interactive (Nasdaq:TTWO), Activision Blizzard (Nasdaq:ATVI), Konami (NYSE:KNM), THQ (Nasdaq: THQI), and so on are publicly traded. (To read more about mergers and acquisitions, see The Wacky World of M&As.)

Developers face more volatility than console producers but the upward trend in size has helped them stabilize a bit. For example, EA has a strong sports franchise that annually updates a number of titles that have a loyal following. Unfortunately, EA has seen the cost of its exclusivity contracts rise as competitors try to muscle in with their own sports games.

In addition to cutthroat competition, developers face legislative risk in the form of ratings battles like those that plagued Take-Two's Grand Theft Auto series. By investing in several developers, it's possible to enjoy strong sales in video games while also minimizing the risks inherent in any single developer.

The Retailers
Video games have to pass through retailers before they end up under Christmas trees. While big retailers like Wal-Mart (NYSE:WMT) and Best Buy (NYSE:BBY) account for a percentage of game sales, they also come with other products so that the sales of video games play only a small part.

Specialized retailers in video games were single-city operations until GameStop (NYSE:GME) came along in the 1990s. As of 2008, GameStop is the world's largest video game retailer and as a result, may represent a safer investment in the industry.

Getting Your Game On
When it comes to investing in the video game industry, the secret for investors is to take advantage of the overall growth in the industry rather than trying to pick a single winner. This can be done by either diversifying among the various producers and developers or simply buying into a retailer like GameStop that follows the industry as a whole. The video game industry is a good place to power up your portfolio, as long as you avoid the pitfall of putting all your coins into one company.

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