Has GameStop Become the Perfect Stock?

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if GameStop (NYSE: GME  ) fits the bill.

The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

  • 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 mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
  • Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
  • Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
  • Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. 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% 15.6% Pass
  1-Year Revenue Growth > 12% 3.9% Fail
Margins Gross Margin > 35% 27.3% Fail
  Net Margin > 15% 4.2% Fail
Balance Sheet Debt to Equity < 50% 4.2% Pass
  Current Ratio > 1.3 1.06 Fail
Opportunities Return on Equity > 15% 14.0% Fail
Valuation Normalized P/E < 20 9.24 Pass
Dividends Current Yield > 2% 0% Fail
  5-Year Dividend Growth > 10% 0% Fail
       
  Total Score   3 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at GameStop last year, the video game retailer hasn't seen its score move at all. The company still faces huge threats from competitors both among traditional retailers and from video game makers themselves.

For a long time, GameStop had the video game market cornered. With its then-unique model of buying back used games for store credit and then reselling them at a profit, GameStop filled an important niche among cash-strapped gamers.

But GameStop didn't have the moat to keep out competitors. Big-box retailer Best Buy (NYSE: BBY  ) came out with a trade-in service of its own that took away some of GameStop's ability to maintain high margins in that market niche. Amazon.com (Nasdaq: AMZN  ) has followed with its own trade-in program, conveniently including shipping. As a result, GameStop has had to guide comps downward repeatedly for the current fiscal year.

The bigger long-term threat, though, comes from game companies. Digital distribution has become a huge growth area for Electronic Arts (Nasdaq: EA  ) and Activision Blizzard (Nasdaq: ATVI  ) , and it's one that those two companies and its game-creating peers are likely to emphasize going forward as it cuts out a level of middleman skimming profits. Although GameStop is trying to put itself into position to tap into digital sales -- the company saw 60% growth in the area according to its recent guidance -- it's unlikely to maintain that foothold for long.

GameStop appears to be an old-school company in a rapidly evolving industry. It's unclear exactly what the company has to do, but whatever it is, GameStop will need to reinvent itself in order to survive.

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.

GameStop may not be firing on all cylinders right now, but we've got some other names that should treat you much better. Please accept my invitation to receive the Fool's latest special report absolutely free. Inside, you'll learn the names of three promising stocks for the long haul. But don't wait -- click here and read it today.

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. The Motley Fool owns shares of Amazon.com, Activision Blizzard, GameStop, and Best Buy, and has written calls on Activision Blizzard. Motley Fool newsletter services have recommended buying shares of Activision Blizzard and Amazon.com, creating a synthetic long position in Activision Blizzard, and writing covered calls in GameStop and Best Buy. 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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