Is GameStop the Perfect Stock?

Everyone would love to find the perfect stock. But will you ever really find a stock that gives you everything you could possibly want?

One thing's for sure: If you don't look, you'll never find truly great investments. So let's first take a look at what you'd want to see from a perfect stock, and then decide if GameStop (NYSE: GME  ) fits the bill.

The quest for perfection
When you're looking for great stocks, you have to do your due diligence. It's not enough to rely on a single measure, because a stock that looks great based on one factor may turn out to be horrible in other ways. The best stocks, however, excel in many different areas, which all come together to make up a very attractive picture.

Some of the most basic yet important things to look for in a stock are:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales don't mean anything if a company can't turn them into profits. Strong margins ensure a company is able to turn revenue into profit.
  • Balance sheet. Debt-laden companies have banks and bondholders competing with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Companies need to be able to turn their resources into profitable business opportunities. Return on equity helps measure how well a company is finding those opportunities.
  • Valuation. You can't afford to pay too much for even the best companies. Earnings multiples are simple, but using normalized figures gives you a sense of how valuation fits into a longer-term context.
  • Dividends. Investors are demanding tangible proof of profits, and there's nothing more tangible than getting a check every three months. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at GameStop.

Factor

What We Want to See

Actual

Pass or Fail?

Growth 5-Year Annual Revenue Growth > 15% 34.3% pass
  1-Year Revenue Growth > 12% 2.9% fail
Margins Gross Margin > 35% 27% fail
  Net Margin > 15% 4.1% fail
Balance Sheet Debt to Equity < 50% 9% pass
  Current Ratio > 1.3 1.11 fail
Opportunities Return on Equity > 15% 14.3% fail
Valuation Normalized P/E < 20 9.55 pass
Dividends Current Yield > 2% 0% fail
  5-Year Dividend Growth > 10% 0% fail
       
  Total Score   3 out of 10

Source: Capital IQ, a division of Standard and Poor's. Total score = number of passes.

Getting just 3 points, GameStop isn't going to make its way onto the high-score list. After enjoying years of strong results in its narrow niche, the company now finds itself with a whole lot more competition.

GameStop has a simple yet effective business model. It has thousands of modest retail stores that are packed with video games and game systems, and it's best known for its innovative practice of acting as a clearinghouse for used video games, buying them from customers and then reselling them at a healthy markup.

For a long time, GameStop had this narrow market largely to itself. But now it faces competition on several fronts. Earlier this year, Best Buy (NYSE: BBY  ) began offering used video games. At the same time, game makers Electronic Arts (Nasdaq: ERTS  ) and Take-Two Interactive (Nasdaq: TTWO  ) are trying to eliminate the retail middleman entirely, using digital download technology to deliver their products directly to gamers.

At its current price, GameStop's stock clearly reflects those competitive concerns. But the company's management team has dealt with similar concerns before. And with the recent release of the Kinect as well as the latest installment of Activision Blizzard's (Nasdaq: ATVI  ) Call of Duty series, prospects for the video game industry generally may finally be looking up after years of struggles. That won't make GameStop a perfect stock, but it could pull it out of its recent malaise.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

Click here to add GameStop to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned in this article. Best Buy is a Motley Fool Inside Value recommendation. Take-Two Interactive is a Motley Fool Rule Breakers selection. Activision Blizzard and Best Buy are Motley Fool Stock Advisor picks. Motley Fool Options has recommended a synthetic long position on Activision Blizzard, buying calls on Best Buy, and writing covered calls on GameStop. The Fool owns shares of Activision Blizzard, Best Buy, GameStop, and Take-Two Interactive. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.


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