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GameStop a Fatality?

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Is it truly "Game Over!" for GameStop (NYSE: GME  ) ?

Watching the stock tumble 16% in the wake of third-quarter earnings, it's apparent that Wall Street thinks so -- and it's no mystery why. Lulled into complacency by the company's record of posting quarter after quarter of gangbusters growth, investors (including yours Fool-y) were surprised to see sales growth drop into the single digits Wednesday, and profits drop ... period.

And yet, GameStop still managed to move $1.7 billion in box-sized virtual entertainment sales last quarter. While profits fell 10% on a GAAP basis (to $0.28 per share), they appear to have exceeded by a penny Wall Street's estimate of $0.37, pro forma. (Pro forma, in this case, means what profits would have been if GameStop had incurred no "merger-related costs, foreign currency fluctuations, and debt extinguishment expenses.")

Considering that the year-ago numbers were inflated by sales of the then-just-released Halo 3 for Microsoft's (Nasdaq: MSFT  ) Xbox, and that we're in the middle of a recession that Goldman Sachs is calling the worst since the Great Depression, and barreling toward what Wachovia predicts will be 9% nationwide unemployment … well, perhaps a little bit of weakness shouldn't have come as a surprise.

The real surprise, to my mind, is that business remains as brisk as it is. Software giants Electronic Arts (Nasdaq: ERTS  ) and Activision Blizzard (Nasdaq: ATVI  ) are still churning out new titles, and GameStop management believes it will still end this year with sales up more than 20% year over year, and profits up a robust 30% or better.

The real surprise is that Wall Street thinks performance like this is worth a measly 7.1 times projected earnings (of $2.45). For a 20% grower, that's just insane. For a 20% grower in a recession -- well, I'm flummoxed. I just don't know what word can describe the level of past-insanity implied by GameStop's current valuation.

Honestly, the only word that comes to mind is: "Buy."

But do the master investors at Motley Fool Stock Advisor agree? Take a free 30-day trial and find out.

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Fool contributor Rich Smith does not own shares of any company named above. Why do we tell you this? Because The Motley Fool has a disclosure policy.

Microsoft is a Motley Fool Inside Value pick. GameStop, Electronic Arts, and Activision Blizzard are Motley Fool Stock Advisor picks.

Read/Post Comments (4) | Recommend This Article (11)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 21, 2008, at 2:18 PM, SteveTheInvestor wrote:

    Well, Stock Advisor loves GME. It's one of their huge winners. Oh wait.... used to be one of their huge winners. It crashed back to earth. In regards to Wall St. and their valuation, I'm thinking that basically nobody trusts that growth will be there. Can't say as I blame them. Huge numbers of retailers are folding and/or closing stores. This isn't a correction. This is a major bear market and nasty, nasty economy. Go ahead and buy if you want, but I don't think I would get too comfortable and believe that it can't go lower.

  • Report this Comment On November 21, 2008, at 2:56 PM, jlwood830 wrote:

    While yes, any stock can go lower, the simple truth is this one should be going higher Fools. So call a spade a spade. It's still a buy for me and I'm going to buy it for as long as I have the money to... just like those gamers do, just like those Christmas gift givers do. This company is obviously coming out on the right side of the recession. Are you going to be on the right side of it too?

  • Report this Comment On November 21, 2008, at 2:58 PM, esxokm wrote:

    I have to agree with Steve the Investor. We have to remember that Wall Street may be pricing in uncertainty. We really are in a period where irrationality seems to be king. While GME will do well over time, you have to ask yourself: how long are you willing to hold it? That will be key. Also, even though I say it will do well over time, I'm really no clairvoyant. I can't predict how things will turn out. What if the economy gets really bad and stays like that for years, like Japan? We are, after all, almost near 0% in terms of Fed funds rates.

    Rich is right -- this is a compelling situation. Just remember, it takes guts right now to be a value investor and it takes no guts to be a short-seller...if that doesn't tell you the world is screwed up, I don't know what else will! Best of luck to everyone...

  • Report this Comment On November 22, 2008, at 9:34 AM, dowwhiz wrote:

    I think it a mistake to consider the low multiples as "too low" for two reasons. First, obviously investors do not believe earnings estimates for 2009-2010, and second the equity risk premium assigned to stocks in general has risen dramatically, thereby lowering the value of future cash flows. After a period like this, combined with the NASDAQ crash of 2001, confidence in equities can stay low for a long time, and high beta stocks like GME are the greatest casualties.

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