June 30, 2022

StrategisChhr

Skillful Business Crafters

Is GameStop a Buy After Earnings?

Video game retailer GameStop (GME -2.75%) is arguably the face of the meme stock craze that started more than a year ago. The stock has fallen well off of its highs but remains up more than 500% since the start of 2021.

The company recently reported its first-quarter earnings, and investors want to know whether this is a turnaround story or a company dying a slow death. While results showed the business could be around for a while, investors should think before running to buy the stock.

Enough cash to last a while

GameStop’s balance sheet offered the most significant investor takeaways from the company’s earnings. Management smartly raised a lot of cash when the stock’s historic short squeeze sent shares soaring from single digits to almost $350 per share.

Image source: Getty Images.

The price move arguably defied logic, but it benefited GameStop since issuing shares at those levels allowed the company to raise more money without the new shares overly diluting existing shareholders. You can see below how GameStop raised more than a billion dollars throughout 2021, enough money to pay down its debt and still have more than $1.5 billion left on the balance sheet to fund the business. In that process, shares outstanding have only increased about 16% since the beginning of last year.

Data by YCharts.

It’s a clean financial slate for GameStop, which now has the resources to evolve its business model without the worry or restraint of needing more funding. The company’s operating losses totaled $154 million in the first quarter, so it could run for several quarters at that rate without worrying about its cash balance.

“Big picture” pressure isn’t going away

But if a company can’t change for the better, a clean slate won’t help it over the long term. GameStop has potentially benefited from a general shortage of next-generation gaming consoles herding consumer traffic to its stores, because gamers are going wherever they can find them. Management invested heavily in inventory last quarter to benefit from this traffic, ramping up that line item to $918 million, up from $571 million in the prior-year period.

Investors don’t know how consumers will shop once consoles become more available over time. Physical game discs are quickly losing their popularity as gamers can now easily download titles right from their consoles.

Where does GameStop factor into this transaction cycle over time? Not only do digital games potentially prevent the need for consumers to visit their local GameStop, but it also threatens the resale market as you cannot trade in digital games.

New business ventures are a wild card

GameStop is aware of this threat and focused on bringing new businesses online, including a digital wallet for gamers to send and receive cryptocurrencies and non-fungible tokens (NFTs). 

These new asset classes are just starting to go mainstream, so gauging how they might impact the business is challenging. Perhaps digital assets are game-changers for GameStop, but investors have almost no way to know whether it will be enough if hardware and software sales struggle.

In other words, it’s a “wait and see” for investors, making it hard to develop an investment thesis.

Investor takeaway

Long-term uncertainty could be GameStop’s biggest problem for investors. Yes, the company has enough cash to alleviate near-term financial concerns, and getting into digital assets could be a huge success (or just as easily a failure). Meanwhile, it’s hard to get excited about the legacy business as shoppers haven’t indicated they’ll stick around once consoles aren’t hard to come by.

The stock is still expensive too, trading at a price-to-sales ratio of 1.8, over four times as expensive as a comparable electronics retailer like Best Buy. Investors are paying a premium for a stock that has more questions than answers, so understand the risks before diving in.


https://www.fool.com/investing/2022/06/09/is-gamestop-a-buy-after-earnings/

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