There's a sales cycle that tends to repeat itself with each new generation of consoles--one marked by slow sales in the months preceding the new generation as gamers save their money in anticipation of the next big thing, and a subsequent spike in sales in the year following the introduction of the new generation.

In a memo assessing the year in gaming so far, Wedbush Morgan analyst Michael Pachter cautions against viewing the expected fall release of Microsoft's next console as the beginning of the measurable growth in the next-generation cycle.

"We believe that market perception will cause entertainment software stocks to fluctuate within a narrow range until there is better visibility into software demand," Pachter wrote in his memo. "We think that many investors have misinterpreted the launch of the Xbox 360 as the beginning of the next generation, and expect rapid sales growth in 2006. In contrast, we expect the launch of Sony's PS3 (expected in late 2006) to mark the beginning of the next cycle, and think that rapid sales growth will not materialize until 2007."

This means that the early next-generation sales growth many investors are expecting at the beginning of next year won't materialize as gamers hold off on purchases in anticipation of the PlayStation 3 launch.

Elsewhere in the memo, Pachter predicts that console and PC sales will finish the year up 10 percent over 2004, that a price cut for the redesigned PlayStation 2 will be enacted "no later than fall," and that the PlayStation Portable and Nintendo DS will have similarly successful years, moving 3.5 million and 3.6 million units, respectively.

Not surprisingly, Pachter believes that the PSP will expand the market beyond the younger audience targeted by the DS. He does extend his outlook of how the PSP will impact the game sector by suggesting any upside to software sales for the PSP will correspond to a decline in software sales for other consoles. "We expect the [PSP] to compete with other consoles for both consumers' time and disposable income," Pachter said

Pachter maintains Buy and Hold recommendations on GameStop and Electronics Boutique stock, respectively, saying that while he thinks the recent proposed merger of the two companies is mutually beneficial, it is possible (though unlikely) that the Federal Trade Commission will challenge the merger based on EB's overwhelming concentration in the used games market in the United States.

Overall, Pachter sees little volatility for the companies he covers, saying, "Publisher stock will likely trade in a narrow range over the next few months, due to uncertainty surrounding the impact of the introduction of the Microsoft Xbox 360 console."

So while '05 is looking strong, based on Pachter's assumptions of "a combination of strong release schedule, easy comparisons, and the PSP launch," according to Pachter, the future is less clear. "We think that many investors will be lulled into a false sense of security, causing software publisher stocks to appreciate during the middle part of the year," but then hitting more difficult times in the back of the year. Comps will be "difficult," says Pachter, and "consumer reaction to the Xbox 360 launch may disappoint," leading to share prices that could languish or decline. "We believe that publisher stocks may decline once the summer malaise begins, and once a greater number of investors adopt our thesis that 2006 is the console transition year."