Gambling on Gaming

Roulette may have tough odds, but at least when you bet on black and the house comes up red, it happens in an instant.

For gambling investors, 2008 must feel like watching a slow-motion spin of a rigged wheel.

ETFs in the sector look awful:

• Van Eck Global's Market Vectors Gaming ETF (BJK)—off almost 58 percent
• PowerShares Dynamic Leisure & Entertainment ETF (PEJ)—off more than 40 percent

Former high flying stocks look worse:

• Wynn Resorts (WYNN)—down 53 percent this year
• Las Vegas Sands (LVS)—off more than 88 percent (even after billionaire CEO Sheldon Adelson pumped in $475 million)

The worst may not be over.

Goldman Sachs slashed its earnings and price targets across the gaming sector, even though shares of most big-name casinos and equipment makers have already been absolutely slaughtered this year. Goldman sees balance-sheet risk, longer lead times on new construction, and less cash from condo and land sales.

Value investors still probably see a lot to like here, but the macro uncertainty makes Goldman less willing to give them the benefit of the doubt. Analysts say the third quarter could be an "inflection point" for a lot of companies, noting that "between now and higher stock prices, there need to be capital raises, reassessment of unit growth opportunities, and stabilization in trends. Balance sheets remain the focus for operators."

Basically, hefty debt was a rule in the industry for years, and cheap credit helped move massive construction projects along. The credit crunch came at the same time gamblers might be rethinking how much cash they have to toss around in a slow economy. The environment looks as if it could get worse, not better.

That said, investors love making a bet when the chips are down. Gaming stocks were great performers in the bull market and big losers in the bear market, so even though they're down, at some point it'll be worth revisiting them. Today, Investors Intelligence saw sentiment on the gaming sector turn bullish.

If you're feeling lucky, here are Goldman's favorites in the sector:

For exposure to the space, our top picks are Penn (balance sheet, valuation), followed by Las Vegas Sands (exposure to Asia, highest risk/reward), and Pinnacle (solid markets, offensive growth opportunities, valuation).