GameStop (NYSE:GME) has been one of the year’s most amazing stories. Coming into 2021, GameStop appeared to be a nearly bankrupt video game retailer stuck in a death spiral. However, thanks to social media activism, GME stock flew to the moon in January.
Management used that opportunity to issue stock and raise sufficient cash to keep the business afloat. The company has also brought in leaders such as Ryan Cohen who can hope to get the company back on track with a new strategy.
Perhaps under Cohen’s watch, GameStop will be able to form a digital approach to evolve its business model. While the traditional mall-based sales model is on the way out, video games are more popular than ever. There’s a chance to pivot GameStop to digital sales channels or pursue new opportunities such as e-sports or non-fungible tokens (NFTs).
GameStop’s Disappointing Earnings
I know meme traders don’t want to hear about earnings. However, if you are going to invest, fundamentals eventually matter. For a short period of time, a stock price can simply go up based on sentiment or technical factors. Sooner or later, however, a company actually needs to earn money or show strong growth to maintain its shareholder value. GameStop, however, is not doing this yet.
GameStop isn’t expecting to report Q3 earnings until December. However, looking back at its Q2 earnings, they were a big mess. The company lost 85 cents per share, which was a sizable miss versus expectations. Revenues grew 25% year-over-year, which might sound good at first glance. However, it actually isn’t that big of a jump, considering that the stores were largely closed in Q2 of 2020. Economic reopening could have led to a much bigger revenue increase, particularly given the strong video game sales trend.
Overall, for Q2, the company lost $58 million while generating $1.18 billion of sales. That’s around a negative 5% profit margin. This isn’t a disaster, by any means, but normally investors would value a small loss-making retailer like this at a low valuation ratio. Instead, GME stock is currently at a rather lofty price.
On a profit basis, GameStop is also exceptionally expensive. Analysts expect the company to continue losing money in 2022. In 2023, analysts see GameStop generating 15 cents per share in operating profit. This would add up to a P/E ratio of around 1,400.
Share Price Gyrations
Clearly, GameStop isn’t rallying based on anything to do with its (poor) fundamentals. Rather, most of the action is due to short-term sentiment swings and technical factors.
Since this spring, GameStop has traded in a range between $150 and $300 per share. It tests the edges of those ranges occasionally, but it tends to settle back to around $200 per share most of the time. It’s been frustrating for both shareholders and short sellers; both want to see a big move, but instead the stock just hangs out in its narrow area.
Over time, however, an overvalued stock will tend to drift down toward its fair value if there are no positive catalysts to keep sentiment up. Earnings in December are likely to be bad; analysts don’t see the company making profits until 2023, after all. And the supply chain and logisitics problems may cause GameStop issues this holiday season. We’ve already seen bad earnings from other mall retailers like Gap (NYSE:GPS) which serve as a warning for the sector as a whole.
In November, GameStop shares rallied once again. They topped out at $250 recently. However, there was little actual news to justify such a move. Thus, not surprisingly, the surge came to an abrupt end Tuesday, as GME stock tumbled 13.6% in a single day. The meme energy has dimmed dramatically since the first GameStop squeeze back in January.
GME Stock Verdict
GameStop remains in a difficult position as an investment. The actual value of GameStop’s existing operating business is minimal. The company was barely surviving prior to the pandemic. And foot traffic to malls has dropped significantly since then; GameStop’s legacy brick and mortar business is not going to be a meaningful profit center for much longer.
Will GameStop be able to develop a large sustainable online business? We still don’t know. There’s been a lot of rumors and excitement around what could be. Until some tangible signs of actual progress occur, GME stock is a gamble at best. And with the market capitalization up at $15 billion, it’s an awfully expensive lotto ticket at that.
This article originally ran on investorplace.com.