Understanding Nintendo's drop

Hi reader,

Nintendo reported earnings last week, and as many of you might have seen, dropped quite considerably the following day in US markets. The Japanese market was closed when Nintendo reported earnings, but the stock dropped quite considerably today due to earnings and coupled with some macro fears. As a small note, the Yen also appreciated quite considerably, meaning that if you invest in the US ticker, then you might see a different performance:

This drop is something that I anticipated might happen (to an extent) after seeing the company’s numbers. I thought it would be a good idea to bring a short take on the earnings to help you understand why this drop made little sense, at least when looking at the company’s fundamentals. This will not be an extremely detailed article but rather one with a quick take because it’s all we need to understand that the thesis is still on track.

What caused the earnings drop?

The first question we must answer is what got investors so worried. A quick glance at the company’s presentation already gives us a good indication of what might have caused the drop. Pretty much all of the company’s financial numbers were down considerably compared to the same quarter a year ago…

Source: Nintendo’s earnings presentation

These are obviously not minor drops, and I understand why they might appear worrying when looked at without context. I recall talking with a Japanese investor who told me that individual domestic investors are starting to gain penetration in financial markets and that these investors tend to be unsophisticated. This means that they tend to react violently to stock price moves and don’t tend to do deep research on their holdings. Of course, this happens in every country in the world, but in a country like Japan, where individual investors have been absent from the market for many years, it occurs to a greater extent. I follow several individual investors in Japan, and I can say this definitely makes sense.

But, why isn’t this drop worrying? Let’s answer that now.

Why isn’t this worrying?

This drop is not worrying mainly because it was caused almost entirely by a combination of two factors…

1. Tough comps

2. The end of the Switch’s lifecycle

(Note that, as I discussed earlier, there are also macro factors impacting Japanese stocks, but I will focus here on the fundamentals)

Both should’ve been expected beforehand, and it’s quite astonishing how much it surprised the market. Let’s start with the first one.

Q1 2025 compares to Q1 2024 (the above growth rates are year-over-year), a quarter where the company had two very important releases that “inflated” its earnings. More than inflated earnings, I’d say that these two releases gave investors a taste of what the company is capable of if it exploits its IP more recurrently. These were the release of the Mario movie and the new Zelda game. Both had an outsized impact on Q1, which was much stronger than it had historically been (pretty evident in the graph below, by the way):

Nintendo’s Q1 is typically a soft quarter, but this “seasonality” was completely absent last year due to both releases. The Mario movie not only brought direct revenue but also stimulated the sales of software and hardware. The Zelda game was a home run, selling almost 16 million copies in 8 weeks. Not only was it a significant software release (which was absent this quarter), but the company achieved the most significant software sell-through in a first quarter ever thanks to this game:

Source: Nintendo’s earnings presentation

The Mario movie's impact on the sale of hardware and software and the impact of the Zelda game on hardware units sold were impossible to quantify directly. Still, looking at the following chart already makes it quite evident. Nintendo managed to grow the number of hardware and software units quite materially despite the system being at the time entering its seventh year, something unprecedented:

Source: Nintendo’s earnings presentation

Of course, this profoundly impacted the company’s Q1 2024 financials. One does not expect to see the following growth rates during a hardware downcycle:

Source: Nintendo’s earnings presentation

With no new movies released (although a couple planned for the coming years) and no similar software hits, getting close to these numbers this quarter was almost impossible. Let’s not forget that Nintendo is getting ready to launch the new hardware (or at least to announce it) during this fiscal year, meaning that it’s highly unlikely the company will launch a blockbuster game before it comes out. Don’t forget that, in this business, software sells hardware, so it would be a terrible idea to exploit the IP on declining hardware when there’s new hardware planned for the near term.

Note that there was significant operating deleverage this quarter, as there was significant operating leverage in the comparable quarter. This is normal because software grew quite considerably when the Mario movie and the Zelda game were released, and software has a much higher margin than hardware. To this, we must add the Mario Movie's impact on costs, as it allowed Nintendo to spend little on marketing to drive strong sales (back then I referred to it as “paid marketing”). With software sales dropping significantly and without the help of a movie to promote the Switch, it’s normal to see operating deleverage.

The tough comps should’ve been expected, the same way that the strong Q1 last year could’ve been anticipated. In fact, I titled my FY 2023 earnings digest article on Seeking Alpha ‘The Calm Before the Storm’ and my Q1 2024 article ‘The storm has arrived.’ This quarter might well be known as ‘The calm after the storm.’

Looking below surface

Barring the tough comps, the performance of the company was pretty good. Let’s not forget this hardware system is going into its eighth year, something unprecedented for Nintendo. All the quarters from now until the new hardware release are transition periods, but let’s look at some good news.

The company sold 2.1 million hardware units and 30.6 million software units this quarter. This obviously doesn’t compare well to a year ago, but how does it compare to other quarters? Let’s take, for example, Q4 last year (so the prior quarter). Pretty much most quarters last year were impacted by the two releases I talked about above to a greater or lesser extent, but it’s the only quarter I can take that’s not a christmas quarter (and thus impacted significantly by seasonality, like the company’s Q3) or significantly impacted by the two releases.

Nintendo sold 1.96 million hardware units and 35.7 million software units last quarter. This means that hardware units sold grew sequentially, and software units “barely” fell 15%.

Source: Made by Best Anchor Stocks

Of course, there’s an element of seasonality here as Q4 tends to be the company’s weakest quarter, but I’d say these numbers are pretty remarkable considering that…

1. The Switch is in its eighth year

2. There have been no blockbuster software releases

3. The new hardware has already been announced

The third one is interesting because people tend to defer purchases of hardware when a new version has been announced, but this has not happened with the Switch.

Management went as far as to reiterate the guidance given last quarter, which, let’s not forget, does not include any potential hardware release this fiscal year (they want to keep it as a surprise):

Source: Nintendo’s earnings presentation

Considering the current software lineup, it seems like a tough benchmark to beat. Anyway, what I wanted to portray with this article is not that Nintendo will meet this guidance but that the numbers this quarter were much better than they might appear at first sight. If anything, I would take the comparable quarter (Q1 last year) as a sign of what Nintendo can achieve by exploiting its IP more than this quarter as a sign of trouble ahead.

The thesis is still intact, and we are currently in a transition period where I will take advantage of what the market is giving me despite Nintendo already being a significant position for me. Remember that many algos and individual investors are making decisions based on that first slide I shared on this earnings digest. The reality is that all numbers need context.

In the meantime, keep growing!

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Disclaimer: Leandro holds shares of Nintendo as of the publishing date of this article, which does not constitute formal advice or recommendation; it was uploaded with informational purposes only. Do your own due diligence.