Nintendo: A high-quality business hiding in plain sight
A 50/65 Quality Score and why the market may be underestimating the Switch 2 cycle.
This is a free post showcasing my quality score framework. I typically write about smaller companies and Nintendo is a pretty well covered business, so I decided to not put a paywall. Despite being well covered, it represents a great opportunity right now. There’s no reason to only own small companies for the sake of it and I’m happy to own large enterprises if the case makes sense. Consider subscribing to help me continue to product content for you.
Hey everyone,
Welcome to the next edition of my quality score format, where I break down all 15 points of my quality score framework for a high-quality business. This way we can quickly assess key qualitative and quantitative characteristics of a business.
My Mercado Libre Quality Score post showcases how a full breakdown looks like.
Check out this post if you want more details about the quality score.
Let’s dive in!
A short introduction to the company
Nintendo needs little introduction, it’s one of the greatest collections of IP on the planet. With a >33% stake in the Pokémon company (it’s complicated, but we can be sure it’s above 33%, plus Nintendo owns the rights), by far the biggest grossing media franchise in the world, and #6 Mario alone Nintendo would be a irreplacable IP monster. Below that we also have loved brands like Metroid, the legend of Zelda or Animal Crossing. It’s safe to say that there’s a lot of value here and on top of that we have a management team leveraging this IP to create a deep moat. While Disney continues to exploit its IP with a constant stream of moves, leading to fatigue in the fan base, Nintendo has a very conservative and methodical approach to their IP strategy. Check out my previous analysis to learn more.
Optionality/Innovation (3/3)
Nintendo is an nnovative gaming company with strong optionality in IP. Some people might point out that they aren’t that innovative, if we compare technical innovation to players like Sony or Steam. Of course the hardware and image quality isn’t on par with peers, but Nintendo intentionally has been playing a different game for many years.
The company focuses on making gaming fun, instead of being on the cutting edge of technology. This has allowed them to keep costs low (modern game development with photo realistic graphics is very expensive), while developing innovative experiences like the Switch, Wii or DS.
On top of that, we are now reaching levels where graphics are already so good that the next incremental improvement doesn’t improve the experience much. Nintendo should benefit greatly from this, as they can have great visuals without needing to be on the cutting edge.
There is also lots of optionality to leverage the IP more, be it with new games or other experiences like theme parks or movies. Easily 3/3 points here.
Cash Conversion (2/3)
Cash conversion is cyclical, because the company is in a console cycle where you have a lot of upfront development and investment to build inventory for the new consoles to then sell the high margin software once you have an installed base. Nintendo should’ve seen trough cash conversion over the last quarters, as the build up of Switch2 inventory strained cash generation. Over the coming years this should scale with an increasing installed base and Nintendo Switch Online (NSO) increasing penetration.
Management Alignment (2/5)
Management alignment is tough, because there are points for both directions. Most of comp is performance based on EBIT and last 3 year average EBIT, which is not a bad metric to focus on. It could be better, using ROIC or other efficiency metrics, but I won’t complain too much here. A big negative is that there’s no insider ownership, but then we also have Japanese culture: A great example was that management took a paycut when the Wii U console was a flop, showing alignment to company performance.
Overall, management is very conservative and has some backwards stances on topics like social media and E-Sports (They’ve been copy right striking youtube videos in the past, which is basically free advertisment. They’ve also been unsupportive of the E-Sports, i.e. for Super Smash, which could be a great funnel as other franchises like Counter Strike and League of Legends showed). Overall, I can’t give more than 3 points, but I’ll stick with 2/5 for now.
Secular Trends (4/4)
Nintendo benefits from secular trends of an increasing demand for high-quality entertainment. Following the tough market after Covid lockdowns ended, estimates see the console gaming market growing at a 6% CAGR. While this isn’t too fast, we should consider that Nintendo is actively taking market share and competitors like Xbox are struggeling (Xbox is just a small segment for Microsoft, not well managed and in an identity crisis). Strong tailwinds to support a 4/4 score.
Margins (3/5)
Margins are volatile for Nintendo, for reasons discussed above. There are reasons to believe that margins will structurally go higher from here:
Increasing platform dynamics (Switch 1 (SW1) games can be played on Switch 2 (SW2), so you don’t lose all your audience with a new console launch.
NSO online penetration, is still low, but should increase as Nintendo is pushing towards it. This gives them predictable high margin recurring revenue.
Increasing digital penetration, since Nintendo still sells much more physical games compared to peers. One reason is that they target a younger audience and you’d rather give a child a packaged game than a download code. Digital is higher margin though and will continue to take share. Nintendo is now also selling them for slightly lower prices in many cases.
The biggest downside on the margin structure is the current memory shortage, which has led to increased costs to get devices produced. Nintendo has guided for $615 million (100 billion yen) in extraordinary costs associated to memory and tarrifs. If this situation continues or gets worse, we might see a margin crunch.
Memory is a notoriously cyclical market and it would be the first time a market like that goes parabolic and stays there. I see this as a short term headwind that won’t pressure margins forever. On top of that, Nintendo’s profit center is the games and NSO business, not their hardware devices.
Balance Sheet (3/3)
Nintendo has a very high net cash position, which can be considered both good and bad. On the one hand we have $14 billion in net cash, which dropps enterprise value by a lot, but on the other hand Nintendo has always had a strong cash pile (lowest level over the last 25 years was $5.9 billion in 2003) and is unlikely to do much with it.
In the past, the future looked dark for Nintendo several times when new console generations underperformed and they were burning cash. That’s why they always carry a lot of cash as a safety net. But how much cash do they really need?
The bull case is that they’ll distribute parts of the cash pile back to owners, because they now have such a strong balance sheet already coming into the cash generative part of the cycle. Will they just sit there if their cash pile would rise to $25 billion or so? Time will tell.
We then can also add investments in listed and unlisted companies, most notably their stake in the Pokémon company, which alone should be worth a few billion (again, we don’t know how much of it Nintendo owns). These strategic investments are however incredibly unlikely to be divested and returned to owners. A prudent approach then would be to discount the net cash position in caluculation the EV of the business (i.e. using just 50% of the cash value in the calculation).
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Moat/Competition (9/10)
Nintendo’s moat is missunderstood. On the surface the company competes with several console players like Xbox, Playstation and increasingly Steam as they established their Steam deck handheld. Outside of them, they have also competition from PC gaming, mobile gaming and other forms of entertainment. At the end of the day they are competing for attention.
What people miss is that they have a near monopoly, depite all the competition: Nobody is directly competing for Nintendo’s business. People who buy a Switch do so for the IP (play Mario, Zelda,etc games), they won’t decide between playing Call of Duty on the Switch or a PC. The moat is strengthened by recent moves into the movie and entertainment park business, but I’d say those are incremental. Far more important is to keep their IP relevant and loved, which they are doing a good job of.
I’m giving them 9/10 points here, because they have truly irreplacable IP, even if it doesn’t look like it to some people.
Past growth (3/3)
The average revenue growth of 11% over the last cycle is pretty strong, but they’ve also had catastrophic declines when a console flopped. We have the luxury of already knowing the trajectory of the SW2 though…
Expected growth (5/6)
….and it’s outstanding! The SW2 is on track to be the fastest ever console launch, way faster than the extremely successful SW1 launch. I expect to see continued installed base growth, which will be offset by a declining SW1 user count.
The tricky part in judging growth for Nintendo is that we shouldn’t look at revenue growth, this might actually stagnate or decline. Selling a console for $500 brings a lot more revenue than selling 2 games a year at $70 each, but the games bring a much higher margin profile. Nintendo should be set for years of highly profitable incremental software sales.
ROIC (3/5)
While Nintendo is a pretty capital light business in theory, we see a massive drag on ROIC due to its cash pile. Retained earnings as large as total invested capital, showing that the company hoards cash. It is no wonder that its ROIC figures thus look pretty bad. During its peaks, Nintendo saw ROIC of above 25%, even with their cash pile drag. I still give them a 3/5, because I’m confident that they’ll see scaling NOPAT to offset the large invested capital base and potentially returning more cash to shareholders.
Reinvestment rate (3/5)
Over the last twelve months Nintendo invested 144 billion yen into Sales & Marketing and 177 billion into Research & Development against a revenue base of 2.3 trillion yen and 216 billion in NOPAT. Overall, that shows that they invest a lot of cash back into the business.
On top of that, we also have the negative customer acquisition cost (CAC) associated with movies and other ways Nintendo keeps its brands relevant in our day to day world. If you are paid to advertise your work, you can achieve negative CAC, as Nintendo shows. So the real advertising effect they have is higher than what they are spending.
Capital Return (2/3)
We discussed this point a lot in other points already. Nintendo returns 40% through dividends and does small ocasional buybacks. It should however return much more given the strong balance sheet and incoming cash generation of this part in the cycle.
Cyclicality/visibility (3/4)
While gaming is purely discretionary spending one could argue that there shold be a high cyclicality of this business. While that’s correct, the cyclicality is more depending on their system cycle, which is self inflicted. Gaming is the cheapest form of entertainment, if we look at cost per hour, in many cases. Think about a customer buying Mario Kart for $70 and playing it for 200 hours over the course of 7 years. the cost per hour is hilariously low compared to other alternatives like movies or outdoor activities. We’ve also seen that their business does not really depend on the economy when they climbed new ATHs during the GFC amidst the tailwind of the Nintendo Wii and DS consoles.
Recurring revenue (3/4)
Revenues are transitioning towards higher recurring revenue splits, but at present still depend on selling games and consoles. Digital game sales aren’t a bad business and Nintendo has a large 3P business (the majority of sales volume on its online store, if we consider that 3P volume is recognized as revenue only based on the take rate, while 1P sales are recognized at game sale price.
Working capital management (2/3)
Nintendo has a negative NWC during good years, but is currently under a strategic inventory build up. The cash conversion cycle averages a good 22 days, but has been trending upwards for a while driven by increasing inventory days and declining payables days (remember that we want to push paying our suppliers into the future, so a declining payables days is a negative outcome for a business). Nothing extraordinary, but also not a catastrophy.
Here is my Quality dashboard for with a summary and comparison against my average portfolio. Now, let’s get into the valuation discussion; I intentionally try to separate quality from valuation.
Valuation
Not much has changed on valuation since my last post, so I’ll reference it here.
I will however add a sensitivity analysis. Despite its tailwinds from a record breaking SW2 launch and significant margin expansion outlook the stock trades at a cheap price. We don’t need heroic assumptions to get a good IRR here, mainly just a multiple that’s not 8x EBIT and an EBIT margin that is somewhat within the historical range of 20-40% during a good console (ignoring the positive tailwinds discussed earlier that point towards the higher end of that range). On top of that this model doesn’t factor in special dividends or accelerated buybacks. Cash is fully used against EV, which could be seen as aggressive, but besides that I find the model largely conservative. The risk reward looks good in my opinion, unless the memory situation stays permanent (highly unlikely) and gets worse.
Conclusion
Nintendo holds up as a high quality business, achieving 50/65 points in my quality score framework, slightly below my portfolio average of 52.7 points. The biggest weaknesses of the company are a low insider ownership, their reluctance to return more capital and then inherent cyclicality of the console cycle. You can argue that the last two points are improving, especially the cyclical exposure. Overall, for an EV of $34 billion and a market cap under $50 billion Nintendo presents a good opportunity in a durable company that continues to dominate in its self created niche. Nintendo presents a ~5% position in my portfolio at the moment.
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Nice write up. I have never been adverse to companies holding cash piles for optionality, although I do understand that in corporate Japan it has been more problematic, particularly with such low yields. It's difficult to know whether some of the scepticism around Nintendo's next hardware cycle may be overdone; while not every transition has been successful, history suggests that investors have often underestimated Nintendo's ability to evolve.
FWIW on capital returns - in the wake of the Tokyo Stock Exchange's 2023 capital efficiency reforms, there has arguably been a broader shift in Japanese corporate attitudes towards balance sheets and shareholder returns. Nintendo was not directly targeted by the reforms, the focus was largely on companies trading below book value, but it did subsequently make a modest change to its dividend policy. In November 2025, it increased the formula from the higher of 33% of consolidated operating profit or a 50% consolidated profit payout standard to 40% and 60% respectively, perhaps indicative that the wider governance shift is reaching even companies that were not obvious targets of the reforms.
https://www.nintendo.co.jp/ir/pdf/2025/251104_3e.pdf