Warren Buffett was once quoted as saying that he likes the cigarette business because its product costs a penny to make, sells for a dollar – and is addictive.
While smoking may not be your thing, it pays to keep Mr. Buffett's observation in mind when searching for potential investments. Few things are as attractive from a shareholder's perspective as a business that sells products capable of addicting customers.
Some candidates, like cigarettes and alcohol, are obvious. Producers of these addictive substances can be unusually good investments – that is, if you don't mind the ethical implications of owning such stocks.
Other addictions are less obvious but also intense. Think back to 1985, when Coca-Cola introduced New Coke with a redesigned bottle and a supposedly improved taste. Customers screamed and the stock tanked.
That was a great buying opportunity: Any company with such a passionate customer base is going to do well in the long term. Within months, the old Coke was back, sales jumped and the stock price zoomed.
What other products inspire such loyalty? Apple's iPhones, perhaps. But my son, Ron, has recently pointed out to me that there is an equally addictive sector that has a much lower profile among investors.
I'm referring to video games. If you're like Ron and are a video game fanatic, you're already familiar with how this form of entertainment can hook customers. If you're not, consider this: In Aurora, Colo., a man threatened to blow up a Best Buy store and shoot employees after he learned a video game he had pre-ordered was not in stock.
This story is not as unusual as you may think. In Kansas City, Mo., a customer would not take no for an answer when his local store ran out of the game he wanted. He tried to rob a lucky buyer at gunpoint. The victim grabbed the gun's barrel, risking death, and kept the game. The gunman escaped.
Maybe he wasn't thinking big enough: In a suburb of Paris, robbers hijacked a delivery truck loaded with 6,000 copies of the same game and made off with the booty.
So what game do these addicts crave so much that they're willing to risk jail and even death to get their hands on a copy?
It's Call of Duty: Modern Warfare 3, released two weeks ago. During the first 24 hours that it was available, 6.5 million units were sold for $400-million (U.S.). Even more remarkable, those sales were achieved from only two territories – North America and the U.K.
To put that into perspective, the smash movie Avatar took about six months to reach about $1-billion in revenues. Call of Duty achieved almost half that total in a single day. Based on the dollar amounts sold, analysts say the game's first 24 hours were the most successful launch in any medium in entertainment history.
The lucky company that produces the game is Activision Blizzard Inc. For investors looking for purveyors of (legally) addictive substances, its stock deserves attention.
The enormously popular Call of Duty series accounts for about 30 per cent of Activision's $4-billion-plus in annual sales. The company also produces a myriad of other video games, including Wipeout and Spyro, as well as computer games such as World of Warcraft, Diablo and Starcraft.
No, Activision isn't Apple, where growth is at least somewhat dependable. Activision is a cyclical business. Its revenue swings up and down in line with how customers respond to new releases of a few blockbuster games. Over the past few years, revenue has steadily climbed as the company has acquired other firms and built on its core franchises, but earnings have been all over the place.
In my opinion, the company's main attraction is the devotion of its customer base. Few products are capable of igniting the excitement that Call of Duty did. When you find a company that produces such a magnetic product, it's worth cherishing. You know that customers can't be easily lured away by cut-price rivals. So long as Activision continues to manage its business well, consumers will happily pay premium prices for its products.
Will there be ups and downs? Sure, but at current prices, an investor can endure a bit of volatility. The company just bumped up its outlook for 2011 and trades for only 13 times forward earnings. It pays a dividend and yields about 1.4 per cent. Free cash flow is abundant.
If you want to profit from others' addiction, this is one stock that lets you do so with a clear conscience.