Stocks Take Flight

Summary: The Nasdaq Composite has rebounded this year, but there are still opportunities to invest in entertainment stocks that have yet to recover. Two stocks to consider are Roblox and Tencent Music Entertainment Group. Roblox, a popular gaming platform, has seen revenue growth and has a highly engaged user base, making it a potential long-term investment.
Sep. 05, 2023 08:15
Stocks Take Flight

The Nasdaq Composite has rebounded 31% this year, and yet there are still several opportunities to put money to work in strong companies that haven't joined the rally. One area that is ripe for the picking right now is leading entertainment stocks that got crushed in 2022's bear market.

Two candidates to consider are popular gaming platform Roblox (RBLX 0.53%) and China's leading music streaming company Tencent Music Entertainment Group (TME 2.93%).

Here's why these two stocks are ready to take off.

1. Roblox

Roblox stock is in the doldrums, trading down 36% over the last year, but the business continues to grow revenue, and the number of daily active users has nearly doubled to 65 million over the last three years. It sounds like a great setup for an inevitable climb in the share price.

Roblox has established itself as a mainstream entertainment platform for kids. It's full of user-generated content made by a large community of developers. Many of the games and activities on the platform are free to play, but there's plenty of premium content that can only be unlocked with Robux, a virtual currency that players must purchase with real money -- a key source of revenue.

After sluggish revenue growth last year amid rising inflation, Roblox's revenue metric returned to double-digit percentage growth this year. Revenue was up 15% year over year in the second quarter, on top of 22% in the first quarter. With developers being rewarded for their work and continuing to reinvest those rewards into making better content, all signs point to more growth for Roblox.

But another long-term catalyst that investors should watch is advertising. The advertising shift to digital media platforms is slowly progressing, but it could be a key source of revenue growth over the next decade. Roblox has exactly what advertisers want -- a highly engaged base of young users who are difficult to reach through traditional media channels. Roblox has already formed relationships with top brands like Netflix, Nike, and Kering's Gucci. Through the second quarter, it has had over 200 brand activations in total.

After hitting an all-time high of $141 in 2021, the stock now trades at just $27. That's a price-to-sales ratio of 6.7, which is in line with those of leading video game stocks.

While top video game companies are more profitable, Roblox has a similar opportunity to build a highly profitable business over the long term. It generated a high free cash flow margin of around 20% just a few years ago. As the user base continues to inch closer to 100 million, and the company better monetizes that base, the stock could be trading much higher than it is now.

2. Tencent Music Entertainment

Tencent Music is the leading music streaming provider in China. It operates several popular music apps that reach 594 million monthly active users, which is larger than Spotify. The stock has fallen over recent declines in revenue and monthly active users, partly weighed down by the company's weak performance with social entertainment services. However, Wall Street is undervaluing the profitable growth happening in the online music business.

Revenue from online music services surged 48% year over year in the second quarter, making up 58% of total revenue. Over the past few years, the number of paying users for its online music services has more than doubled and now exceeds 100 million.

To stoke that fire, Tencent Music recently started launching higher sound quality and AI-powered recommendations for its music apps. As it rolls out these improvements, management continues to see a trend of more people willing to pay up for memberships.

Although the company still reported a decline in total monthly active users and only a small increase in total revenue in the second quarter, the company's profits are exploding. The company's adjusted profit jumped 48% over the year-ago quarter thanks to higher margins from growth in memberships, advertising revenue, and original content.

China's economy is still recovering, which is a catalyst for more growth in ad revenue and paying members over the next few years. Moreover, Tencent Music clearly has a long-term opportunity to differentiate its apps with more exclusive content to drive demand.

The stock trades at a forward price-to-earnings ratio of just 13, which is incredibly cheap for a leading music streaming provider, especially one demonstrating such strong momentum in boosting margins and profits.