To Wii or not to Wii

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NEW YORK (CNNMoney.com) -- Nintendo, thanks to the Wii, its groundbreaking game system, is not just the toast of the video game industry. It has also been a hot stock on Wall Street.

Shares of the Japan-based company have skyrocketed more than 165 percent since Nintendo (Charts) released the Wii nearly a year ago. The company reported last month that sales and profits in the first six months of its current fiscal year more than doubled from the same period a year ago.

It's a stunning turnaround for the Kyoto, Japan-based company, which had been struggling to catch up to Microsoft (Charts, Fortune 500) and Sony in the game console business before the Wii started flying off the shelves.

But some analysts worry that the stock may now be overvalued and that its performance will suffer if the Wii's momentum wanes.

At one point this summer, Nintendo's market value surpassed Sony's on the Tokyo stock exchange - a significant achievement when you consider that Sony manufactures a wide range of consumer electronics and owns a film studio, financial services division and half of the Sony BMG record label.

Nintendo, though, is primarily a company whose fortunes are tied to a couple of products, which means it will be under pressure to produce new and exciting games after the Wii matures.

One analyst said Nintendo will be "hard-pressed" to top the Wii. With that in mind, Jay Defibaugh, an analyst for Credit Suisse in Tokyo, wrote in a recent research note that he thinks the stock is slightly overvalued.

On the other hand, analyst Atul Goyal of CLSA, an investment bank based in Tokyo, argues that since the Wii has found its way into so many homes, sales of games for the system will continue to drive Nintendo profits.

"Profits come from software sold for the Wii," Goyal wrote in an email, "and as the installed base expands, profits will rise exponentially."

A big part of Nintendo's strategy with the Wii is to expand its customer base by appealing to "casual gamers."

The Wii's wireless, motion-sensitive controller is designed to make playing video games more intuitive, especially for novice players who might struggle with the multi-button controllers that come with other game systems. Also, with the Wii, Nintendo offers less "gamer-centric" games like tennis, baseball and bowling.

Nintendo has marketed the Wii as a more family-friendly product with games for younger players like "Cosmic Family" and "Cooking Mama: Cook Off" and educational titles like "Big Brain Academy: Wii Degree."

However, Robert Summa, editor and chief of the Global Gaming League, an online community for game enthusiasts, thinks that Nintendo's plan to capture the casual gamer is the wrong approach.

"Hardcore gamers will go out and spend their disposable income on games every month, but a casual gamer will only do that on a whim," Summa said.

Summa points out that Nintendo's handheld device, the DS, was successful because it offered games for casual players. But the Wii is significantly more expensive than the DS and Summa thinks that the average consumer will not be willing to spend the extra money.

"Nintendo saw the success of DS and thought it could translate to the console market, but it's a lot to ask for someone who's not a gamer to spend two or three hundred dollars for a console, where as with the DS it works," Summa said.

Nintendo's intention with the Wii was to revolutionize the video game industry by changing the way games are played. The next challenge for Nintendo will be to build on its momentum by outdoing its own innovations.

Nintendo's president, Satoru Iwata, speaking at the at the E3 Media & Business Summit in July, said the company must "destroy the psychological barrier that separates veteran players from novice players."

In other words, Nintendo hopes to capitalize on its expanded market without alienating the core video game market.

Speaking at the same summit, Nintendo of America President Reggie Fils-Aime said that Nintendo is a "beacon for the entire video game industry," and that video games will soon "take their place alongside TV, movies and music as a staple of leisure entertainment."

Nintendo is hoping that its latest Wii accessory, the Wii Fit, will appeal to the "casual gamer."

Nintendo is marketing the Wii Fit as a product that makes exercise entertaining. It comes with a "balance board" device that players stand on to play exercise-themed games.

But Summa of the Global Gaming League thinks the Wii Fit will flop with devoted gamers. "Hardcore gamers would rather spend their money on a system that appeals to them, like the Xbox 360," he said.

So is Nintendo still a buy? The stock is trading at 28 times estimates for fiscal 2008, which ends in March. Defibaugh thinks that is a bit high.

He thinks that, given the cyclical nature of Nintendo and the difficulty it may have following up the Wii and DS, a P/E of 25 times this year's earnings is a fair value for the stock.

But given how rapidly Nintendo's sales and profits are growing in the short-term, the stock may still be a decent bargain.

According to consensus estimates from Thomson Financial, analysts expect Nintendo's revenues to increase by 63 percent this fiscal year and that earnings will increase by 67 percent.

These projections could turn out to be too low. Goyal recently raised his fiscal 2008 sales forecast for the company by 21 percent, citing stronger than expected Wii sales. He expects Nintendo's revenue to increase 86 percent from a year ago.

"Wii is sold out everywhere," he said, "Investors who invest for profits are going to buy more and more of [the stock]."

Of course, investors interested in Nintendo need to be mindful of the fact that its shares are listed on the Tokyo Stock Exchange.

Investors in the U.S. also have the option of purchasing the stock as an American Depositary Receipt (ADR). This allows investors to buy the stock in U.S. dollars instead of having to open a Japanese investment account and deal with currency exchange rates.

But the average daily volume for Nintendo's ADRs is just 203,000 over the past three months compared to nearly a billion shares of Sony's (Charts) ADRs changing hands on a daily basis. So it may be a little riskier to invest in Nintendo since the stock is not as widely traded in the U.S.

Overall though, Nintendo's prospects still look strong since the popularity of the Wii is showing no signs of peaking anytime soon.