Back in mid-2020, GameStop (GME) was sitting at all-time lows, forced lower with massive short positions by perennial juggernaut hedge funds. With over 140% of shares short, it was a prime candidate for the mother of all short squeezes. As word on social media sites spread like wildfire, the short squeeze started, ultimately leading to a gamma squeeze, pushing GameStop’s share price up nearly 19,000% in a little over 9 months. Since then, there has been an 84% pullback off the highs, prompting many to speculate a value play at current levels, and they may not be wrong.
Certainly, bottom fishers will look at the current price of around $17 and salivate at the $120 highs from just a few years ago. Recently, several analysts have praised GameStop for paying down a significant amount of its debt, placing them on a much sounder financial footing. Currently their Debt/Equity ratio is at 50%, placing it in the lower 1/3 of reporting companies. To put it in contrast, the tech bellwether, Apple (AAPL) has a Debt/Equity ratio of 181%. They are also sitting on $1.19 billion in cash which gives them a tremendous amount of financial flexibility.
Unfortunately, that’s where the good data stops. Going into 2019, they regularly posted positive earnings, albeit small. Since 2020 however, it’s been all downhill. Profit margin: -1.72%, Return on equity: -7.64%, return on assets: -3.38%, EPS (ttm): -0.32, and no dividend. Any investor must question how long a company can continue to lose money before finally throwing in the towel.
More importantly, step back and look at the business model of GameStop. Their business revenue of $5.9 billion breaks down into 3 main groups: hardware & accessories (53%), software (30.7%) and collectibles (16.3%).
Where would you look to buy the latest version of the Xbox, or PlayStation? The answer is probably an online retailer which gives you the best prices. These typically happen with large chains which can negotiate better pricing by buying in bulk. The big dogs that come to mind would be Amazon (AMZN), Best Buy (BBY) and Walmart (WMT). While you may still be a true gamer and decide to go to GameStop for your console and accessories, where are you going to buy your games? Currently 30% of GameStop’s revenue comes from game sales. Yet there are fewer and fewer actual games being physically sold. It’s cheaper for game makers to just stream the game or let you download it. No need for a physical CD or DVD. This will continue to be a thorn in the side for GameStop and I expect it to get worse going forward. The final revenue generator may become one of their best performers: Collectibles. With over 4,400 physical stores around the world, GameStop has a great network of centers to not only sell collectables, but also connect the global collector community with physical in center events. There is big money in this niche market and GameStop has an edge here.
When I look at game stop, I see an eerily similar story to what we saw happen with Blockbuster. Blockbuster was an oasis for movie lovers and families to go and rent a stack of movies to shape their nights and weekends. As Netflix grew, it slowly chipped away at the traditional movie rental market. Ultimately, most of us realized it was just easier to stream everything. At its peak, there were over 9,000 Blockbuster locations around the world. Today, only one remains open in Bend, Oregon.
This Friday, the movie “Dumb Money” will be released in theatres across the US. It follows the dramatic GameStop short squeeze story of 2020 and will most likely create a renewed interest in GameStop stock. This may create a short-lived rally in share price, creating another shorting opportunity for those who see the writing on the wall.
If I were left with only one dollar, I would unequivocally refrain from investing it in GameStop shares. It is the latest victim of our insatiable desire to adopt faster & more efficient technologies. Unless we see GameStop reinvent themselves, the downward trajectory in its share price is destined to continue. The beauty of trading and investing is that some of you will agree with this article, others may say I’m off my rocker. As Master Yoda once stated: “Many of the truths that we cling to depend on our point of view.”.
Happy Trading!
On the date of publication, Merlin Rothfeld did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
