11 Reasons to Avoid GameStop Stock Despite the Hype

What do novel coronavirus vaccines, GameStop (NYSE:GME) and the stock market have in common? They all require research, have risks and support or elevate emotions such as fear, hope and excitement. Coronavirus vaccines are now our biggest hope to return to “normal” in the post-Covid era. For those who will decide to take a vaccine shot there could be some side-effects and risks in the future. With that analogy in place, is it worth taking a shot of GME stock today?

GameStop video game and electronics store logo sign in Bay Terrace, Queens, NY.Source: quietbits / Shutterstock.com

I don’t think so.

GameStop is a company that gained attention for all the wrong reasons in the stock market. Nothing material to its business operations was announced, yet GME stock rose at an astronomical rate in 2021, reaching a 52-week high of $483 compared to its 52-week low of $2.57.

Let’s take a closer look at why you should avoid it.

Beware of Forums and FOMO Effect

If the namesake of the ridiculously popular Reddit forum — r/WallStreetBets — is any indication, then buyers ought to beware. There is too much free information online and much of this information comes at great risks. As a part of this, fake news and manipulation of specific stocks are common today. Would you bet your money on the stock market on advice that lacks arguments in the form of fundamental analysis and ignoring valuation completely? Would you just rush in and buy stocks only because their stock price goes up too fast too soon, without material reasons for doing so?

The price of GME stock went up based on similar manipulation and artificial euphoria. In other words, it rose on thin air.

No Press Release by GameStop

I would expect an official press release by the company to state that its erratic stock price during the recent period has nothing to do with any material information or corporate event. This is part of strong corporate governance. GameStop’s management did nothing to inform the investment public about the news. Instead, it enjoyed free publicity for its stock and it got an artificially inflated valuation and market capitalization.

Declining Sales Growth

Even before the pandemic, GameStop’s revenue growth started to decline. In 2016, it reported revenue of $9.36 billion for fiscal year 2015. Ever since that report, for each year until today, the company reported lower revenue. In 2020, amid the pandemic, revenue was $6.47 billion.

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EBIT After Unusual Expense Is Negative

EBIT is a very important financial metric and an indicator of a company’s profitability. A company should make a profit from its core business before taking into account taxes and any interest expenses. I want to see a company having a positive and even better increasing operating profit during a period examined, focusing on its trend. GameStop has a negative operating profit for the past three consecutive years, as of 2018.

Net Income Is Negative

GameStop started having a decline in its net income in 2017. But at least it had positive though declining net income in 2017 and 2018. The last time it reported positive net income was in 2018 with a figure of $230.4 million. In 2019, a huge loss of $794.8 million was reported. In 2020, it suffered a net loss of $464.4 million.

Total Shareholders’ Equity Has Collapsed

Looking at the Shareholders’ Equity it is a very important financial metric to monitor as it provides information about the financial performance of a stock. Book value is widely used for valuation purposes, and higher numbers are always desirable, rather than lower numbers. A company that performs well should increase its Shareholders’ Equity over time. GameStop had a Shareholders’ Equity of $2.08 billion in 2016. In 2020, the figure reported was $611.5 million.

A Business Plan That Is Not Working

GameStop announced via a Press Release that it will make radical business changes for a new transformation.

For many years now this business model does not work. The financial performance is too poor, I call it dramatic. What is the competitive advantage that GameStop has? Its financial results during the past years are getting worse. An unprofitable company. Yes, the decision to do something to change this very poor financial performance is the right one. But it will take time to show what the results will be.

Free Cash Flow Growth Has Been Too Weak

Free cash flow is among my favorite key financial metrics as it is a measure of profitability and also used for valuation purposes. GameStop has declining free cash flow growth for the past four consecutive years, and in 2020 it reported a negative free cash flow figure of $493 million.

Debt Level Has Increased

In 2016, GameStop had a debt-to-equity ratio of 0.17x. In 2020, this ratio went up to 1.55x, and as for the latest quarter, the ratio stood at 2.02x. Increased debt with very poor financial performance is a very risky mix.

Valuation: Is GME Stock Cheap?

The numbers speak for themselves when you compare the company’s financial ratios to those of its peers in the retail sector and technology retail industry for a relative valuation.

The company has a price-to-sales ratio (Q3 TTM) of 1.53x. The sector and industry’s ratios are 0.86x and 0.44x, respectively. GME’s price-to-book ratio (Q3 MRQ) is 23.74x. The relevant ratios for the sector and industry are 6.07x and 3.44x, respectively.

Long-Term Growth Is Non-Existent

Data from MorningStar shows that the 10-year revenue growth for GameStop is -3.34%. This essentially means that the company has a deeper structural problem, as it cannot increase sales historically. Can this change? I do not know, but I am not optimistic either.

The Bottom Line on GME Stock

For all the arguments explained above, which are based on financial data, I believe the recent rally in GME stock is a pure stock bubble. I find no reason to buy the stock, and investors, traders should be very careful as it is a very risky stock with no catalyst to support it.

On the date of publication, Stavros Georgiadis, CFA, did not have (either directly or indirectly) any positions in the securities mentioned in this article.

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