8 Stocks With High Returns on Invested Capital

VIDEOGAMERS ARE OFTEN platform purists. The graphics freak and the multiplayer half-elf/half-warrior/all-nerd want blazing power and occasional keyboard entry. They use a desktop computer with an easy-open case — perfect for frequent videocard upgrades. The casual bad-guy butcher and the fake-guitar virtuoso want to spend less, ignore technical specs and play in positions ranging from reclined on the futon to standing on the coffee table while making pelvic thrusts to Alice Cooper (who is, I should make clear, an aging male rock star). These players prefer consoles.

Activision-Blizzard (ATVI) can now make everyone happy. It is the product of a July marriage of Activision, whose console hits include Guitar Hero and Call of Duty, and the games division of entertainment giant Vivendi, which publishes the online PC sensation "World of Warcraft." Management originally estimated that sales for the newly combined company would total $4.3 billion next year, making it easily the world's largest videogame maker. That forecast now seems too meek. Analysts are looking for more than $5 billion.

The industry is thus far defying a slowdown in consumer spending. Console game sales in July jumped 41% from a year earlier. Sales of consoles themselves, which foretell game sales, increased 17%. Nintendo's cutesy Wii again stomped its beefier rivals, Microsoft's (MSFT) XBox 360 and Sony's (SNE) PlayStation 3. It outsold them 2-to-1 in July despite a continuance of, to Nintendo's shame, limited availability nearly two years after the Wii's introduction.

Activision-Blizzard, which will now report earnings using a fiscal year ending December rather than the former Activision's fiscal year ending March, looks likely to capture a sizable share of the market next year. In its Christmas quarter this year it's expected to release new Call of Duty and Guitar Hero installments and movie tie-ins based on the latest from James Bond, Madagascar and Spider-Man. It might even ship an eagerly awaited expansion for "World of Warcraft." Next year brings a Tony Hawk skateboarding game, more movie characters like X-Men and Transformers and perhaps re-makes of two popular PC games of years past: Starcraft and Diablo.

Benefits of the merger, I suppose, might include an increased ability to extend console and PC hits to the opposite platform. But the clearest payoff will be cost cuts. Management originally said it would save $50 million to $100 million in 2009 on programmers, marketing, corporate overhead and so on. It now says savings could total $150 million — a modest but welcome boost to profits.

That bodes well for Activision-Blizzard's return on invested capital — profits as a percentage of the value of resources used to generate them. It stands now at about 20%, double the S&P 500 median. Studies suggest that's a promising sign for the stock. The company turned up recently along with seven others in a screen for high ROICs and other flattering traits, like healthy sales and earnings growth. Run the search for yourself anytime using SmartMoney's stock screener and the full list of demands.

I like Activision-Blizzaard's efficiency and improving performance, but I suspect investors will find the stock a better deal in coming months than it is today. Shares fetch an ambitious 24 times the 2009 earnings, judging by early forecasts for the combined company. Either the forecasts will prove low or the stock price, at $33 and change, might prove high. Recent games sales are excellent but hardware sales, while healthy, have slowed from prior quarters. And anyhow, a company of Activision-Blizzard's size would be applauded for growing profits by a mid-teens percentage each year. The stock's current price demands yearly growth of more than 20%.

Even the company seems to want a better deal on its stock. With no debt and more than $1 billion in cash, management recently offered to repurchase a mountain of shares at $27.50 apiece. No takers, naturally.

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