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Hitting Pause at GameStop

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Vindication? Meet my bearish video game thesis.

GameStop (NYSE: GME  ) became the latest grim validation stamp, opening lower this morning after posting dreadful second-quarter results.

Comps fell a staggering 14.1% throughout the video game chain. Expansion helped keep the top-line leak at just a 3.7% slip, to $1.74 billion, but earnings got slammed like a blindsided grappler in THQ's (Nasdaq: THQI  ) UFC 2009 Undisputed -- off 32.3%.

Naturally the comparisons are going to be weak when GameStop's best-selling title happens to be a THQ fighting game. Its hottest-selling game a year ago was Take-Two Interactive's (Nasdaq: TTWO  ) benchmark-shattering Grand Theft Auto 4.

Then again, analysts knew that last year's production would be a hard act to follow. They pegged quarterly profit to clock in at $0.28 a share, short of the $0.34 a share the company earned a year ago. They weren't pessimistic enough. GameStop earned just $0.23 a share.

However, the retailer sees improving year-over-year earnings during the second half. It feels that the new software releases will trump last year's slate, but it does expect comps to remain negative in each of the two final quarters of fiscal 2009. Soft hardware sales -- now at lower price points -- will obviously weigh heavy on the top line.

GameStop would normally weather a hardware storm. Software is where the fatter margins hang out, especially when it comes to the resale of trade-in titles. However, fat cats such as (Nasdaq: AMZN  ) and Best Buy (NYSE: BBY  ) have been trying to make a dent in that lucrative market. Even Wal-Mart Stores (NYSE: WMT  ) has a small interest in the sector, through its third-party deal to collect used games. 

Ultimately, it won't be back to business as usual at GameStop. Three months ago, the chain's guidance called for net income of $2.83 to $2.93 a share this year. It is revising its target sharply lower this morning. It now sees a profit of $2.40 to $2.64 a share. The difference is substantially more than the second quarter's shortcoming. In other words, it's not just adjusting the rearview mirror. The headlights are also dimming.

Value hunters will probably rally around the stock after this morning's damage is done. The single-digit earnings multiple will turn heads. Hopefully the lip-lickers going in will check with the head-scratchers cashing out. As long as GameStop keeps revising its outlook lower every three months, this is a classic value trap.

And we know how diehard gamers hate getting caught in traps. I have three similar stocks that I think will beat out GameStop.

GameStop,, and Best Buy are Motley Fool Stock Advisor picks. Take-Two Interactive Software is a Motley Fool Rule Breakers selection. Best Buy and Wal-Mart are Inside Value selections. The Fool owns shares of Best Buy. Try any of our Foolish newsletters today, free for 30 days.

Longtime Fool contributor Rick Munarriz loves playing video games, but he doesn't own shares in any of the companies mentioned in this story. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.

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Related Tickers

10/24/2016 4:01 PM
GME $25.14 Up +0.13 +0.52%
GameStop CAPS Rating: **
AMZN $838.09 Up +19.10 +2.33% CAPS Rating: ****
BBY $39.46 Down +0.00 +0.00%
Best Buy CAPS Rating: *
THQIQ.DL $0.00 Down +0.00 +0.00%
THQ, Inc. CAPS Rating: **
TTWO $45.91 Up +0.92 +2.04%
Take-Two Interacti… CAPS Rating: ****
WMT $69.19 Up +0.85 +1.24%
Wal-Mart Stores CAPS Rating: ***