NEW YORK (CNN/Money) Ė Taking a gamble on gambling paid off handsomely in 2004. Casino stocks were among the best performers last year.
A wave of consolidation in the sector got Wall Street excited...so much so that even the shares of the companies doing the buying moved substantially higher.
Harrah's Entertainment (Research) gained 34 percent and the company it is buying, Caesars Entertainment (Research), soared 86 percent. MGM Mirage (Research) surged 93 percent while the company it is in the process of acquiring, Mandalay Resort (Research), shot up 58 percent.
And in a smaller deal, Penn National Gaming (Research) increased 162 percent while the company it is purchasing, Argosy Gaming (Research), increased 80 percent.
But investors' affinity for Lady Luck wasn't limited to companies involved in mergers.
Shares of Wynn Resorts (Research), which doesn't even have a casino open yet, skyrocketed nearly 140 percent. And Las Vegas Sands (Research), which went public last month, is up 65 percent since the IPO.
(Given the sector's success, it's worth pointing out that the only major casino operator to crap out in 2004 was Donald Trump's Trump Hotels and Casino Resorts (Research), which filed for Chapter 11 bankruptcy in November.)
So with gains like these, should investors start taking some chips off the table? Or should they let it ride?
Betting on a healthy economy and strong earnings
Analysts say that casino stocks still appear to be a good bet.
|The house wins again: Major casino stocks outperformed the broader market in 2004.
"You are coming off a banner year and comparisons are more difficult. There's no doubt about that," said George Smith, an analyst with Davenport & Co. "But there appears to be a consensus of 3 percent to 4 percent GDP growth in 2005 and with that backdrop, leisure and recreation companies should have a good year."
According to data from Thomson/Baseline, the average estimated earnings increase for a basket of 10 mid-cap and large-cap casino companies in 2004 was 36 percent and profits are expected to rise another 15 percent, on average, in 2005.
Smith said that in particular, expectations of continued job growth in the United States and lower energy costs bode well for casino operators.
The relatively weak dollar is another plus as it should make travel to the United States more attractive for international tourists.
"Foreign business in Las Vegas has been strong and should remain strong," said Eric Hausler, an analyst with Susquehanna Financial Group.
Finally, valuations for the major casino companies remain fairly reasonable, despite last year's big run. The average price-to-earnings ratio for the basket of 10 casino stocks is 21.5, based on 2005 earnings estimates.
And Daniel Davila, an analyst with Sterne, Agee & Leach, said that he thinks casino stocks should be trading at a multiple that is more in line with that of major hotel and lodging companies. A basket of 11 major hotel stocks, including Marriott International (Research), Starwood Hotels & Resorts (Research) and Hilton Hotels (Research), are valued at an average of 27.1 times consensus 2005 earnings forecasts.
"Gaming companies are less cyclical, have strong growth stories and are better managed than most lodging companies," Davila said.
|†based on prices and 2005 earnings estimates as of 12/31/04|
So which casino stocks give investors the best odds of a big payday this year? Analysts said that the group as a whole should do well but that investors shouldn't count on as much takeover activity to lift the sector this year. So it will pay to be more discriminating.
"Consolidation will cool down. There aren't as many companies left to buy," said Hausler. "This will be more of a stock picker's market. People are going to have to focus on select quality names."
With all that in mind, the three analysts favor a mix of names, including some of the larger industry consolidators as well some smaller names with strong growth potential.
Davila and Hausler both said that MGM Mirage and Station Casinos (Research) are among two of their favorite picks. Hausler adds that Penn National is also a good bet. Smith also likes Penn National, as well as Harrah's and Aztar (Research).
None of the analysts quoted in this piece own shares of the companies mentioned and their firms have no investment banking ties with the companies.