Currently, the price of Nintendo shares have been trading in the low 30s, down more than half from its most recent price peak and also trading at prices not seen since early 2007.
Right now, Nintendo has a trailing P/E of 12 and its forward P/E is 9.8, which says to me that is most likely not that expensive. Nintendo also has very good margins and returns on equity and assets.
As for the company itself, I am uncertain how to describe where from it gets most of its profits – is it from the sale of its hardware or is it from the sale of its software? I’m sure I could figure this out with some more research, but a good guess is that most valuable assets of Nintendo are its intellectual property and game franchises and it makes its money through selling software, not hardware. I’m pretty certain that the physical game devices produced by Sony, Nintendo, and Microsoft are often sold at cost or at a loss for many months or even years and that it is the software where these company make their money.
This is important to figure out especially when attempting to value the company using a discounted cash flow analysis. One usually attempts to find the rate at which the “owner earnings” have grown over the years and then project that into the future while discounting the future earnings to their present value. To find owner earnings, one takes the operating cash flow and then subtract the maintenance capex.
One can equate maintenance capex with depreciation and amortization, but this can sometimes provide an inaccurate result. More importantly, in regard to a company like Nintendo where I think its profits come from being able to successfully create, market, and sell new games, one should probably consider research and development and advertising expenses as part of the capital expenditures required to maintain or advance its position in the market place.
To illustrate this point a bit better, here are my estimates for Nintendo’s owner earnings for the past three years:
The first estimate is much more generous as it only counts depreciation while the second estimate is much less generous because it factors in substantial advertising expenses and R&D. I suspect the true amount lies somewhere in between the two estimates, but definitely closer to my second estimate. If I had simply stopped after completing my first estimate and not considered whether advertising and R&D are part of Nintendo’s maintenance capex, I might have deluded myself that shares of Nintendo are trading at a steeper discount (and with a higher margin of safety) than they actually are.
In conclusion, before I even decide to think about purchasing Nintendo, I must do further investigation into how it operates as a business. Concurrently, I will have to attempt to gain a better understanding in how much its advertising and R&D should be considered as part of its maintenance capex. Also, if anyone reading this feels I am mistaken about anything in this post, please let me know by commenting.
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