Gaming (or gambling) stocks like 32Red (LSE: TTR), Ladbrokes (LSE: LAD), Bwin.party Digital Entertainment (LSE: BPTY), 888 (LSE: 888) and Betfair (LSE: BET) may not be for everyone.
However, for those that are not concerned about the ethical implications of investing in gambling, they are interesting investments.
Research has shown that over the past four decades or so, gaming stocks have — as a whole — outperformed the market by around 2% per annum. This trend has been called the ‘sin stock’ anomaly for the simple reason that no one can understand why it occurs.
That being said, not all gaming stocks are created equal. So, which company deserves a place in your portfolio?
Cash machine
As a former shareholder of 32Red, I know that there are two things the company is good at: growing profits and generating cash.
For the five years through to the end of 2015, it’s estimated that 32Red’s annual pre-tax profit will have quadrupled. The group’s earnings per share have grown at a compound annual rate of 33% since 2010.
Moreover, since 2010 32Red has generated around £12m in cash, after capital spending. Of this, the company has returned £4.5m to shareholders, around 7.3p per share.
And the cash returns are unlikely to stop any time soon. 32Red has over £7m of cash on its balance sheet and no debt. According to City analysts, the company is set to yield 4.3% during 2015 and currently trades at a forward P/E of 11.3.
High-street concerns
The big difference between 32Red and Ladbrokes is the formers high-street presence. 32Red offers an online gaming platform while Ladbrokes relies on its high-street presence to generate the majority of its revenue.
Ladbrokes reported a 60% fall in quarter-on-quarter profits during the first three months of this year. The company is now searching for ways to boost its recurring income.
What’s more, Ladbrokes’ online presence has been sliding for some time and competitors surge ahead, concerns over the group’s dividend payout have started to surface.
Ladbrokes is set to yield 6.6% this year although the payout won’t be covered by earnings per share.
Merger mania
Bwin.party is currently conducting preliminary talks with “a number of interested parties regarding a variety of potential business combinations”.
However, the company’s shares have had a terrible year to date, falling by as much as 25%. Nevertheless, City analysts expect the company’s earnings to expand by 25% this year, and Bwin is trading at a PEG ratio of 0.8. The company has a net cash balance and a yield of 3.7% at present levels.
Similarly, 888 became a takeover target earlier this year when William Hill made an offer for the company, which, ultimately failed. But shortly after the deal fell apart, 888 announced a 14% increase in full-year revenues for 2014. Profits for the period jumped by a third.
888’s management remains open to other takeover offers and in the meantime the company’s shares support a dividend yield of 3.5%. 888 trades at a lofty forward P/E of 19.9.
Expensive growth
Lastly, Betfair, which is an expensive bet on the sector. Specifically, the company currently trades at a forward P/E of 33. Earnings per share are set to expand by 53% this year, before falling by 2% during 2016.
However, due to the unpredictable nature of the gambling business, it’s difficult to justify paying such a high premium for Betfair’s shares. A run of bad luck for the gaming company could cut earnings estimates in half, which would send the shares crashing back to earth. Also, the company only offers a token dividend yield of 1.2%.
Only one option
Of these five companies, only one stands out to me: 32Red. The company’s shares are cheap, the group is cash generative and management looks after shareholders.