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Why Is Goldman Warming Up to a Dying Retailer?

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Goldman Sachs apparently isn't afraid of catching a falling steak knife.

Analyst Brian Karimzad is upgrading GameStop (NYSE: GME  ) -- from neutral to buy -- while raising his price target from $20 to $25.

Karimzad isn't necessarily long-term bullish on the company, but he does see a "tactical opportunity" for a bounce in the video game retailer's stock over the next year.

He feels that analyst profit estimates are too low, pointing out how GameStop has been buying back 12% or more of its shares annually to boost profitability on a per-share basis. Between the low earnings multiple and the fat dividend, what's not to love?

Well, how about the real possibility that GameStop is doomed in a few years? Digital delivery will destroy both GameStop's software sales and its even more lucrative software resale business.

What does Goldman Sachs think about GameStop's disappointing quarterly results that saw sales falling 11%? Well, the blame here is apparently going to the video game industry for decreasing the number of titles being put out.

Gee, this isn't OPEC trying to deliberately curb production to orchestrate prices. Developers aren't putting out physical games because folks aren't buying them the way they used to. This isn't news. NPD Group and other industry trackers have been pointing to sliding sales for three years.

Sure, marquee titles are doing just fine. Electronic Arts (Nasdaq: EA  ) reported last week that first-day sales of Madden NFL 13 were up 7%, but it also points out that online usage -- the future for the industry and the end for GameStop -- was up a much heartier 28% in peak simultaneous players.

Is GameStop as bad as Best Buy (NYSE: BBY  ) or RadioShack (NYSE: RSH  ) ? No. GameStop will outlive the train wreck that RadioShack has become with its decimated margins. Best Buy is in better shape than RadioShack, but the lean nature of GameStop's model should allow it to hold out longer despite its clear focus on a category that is going digital.

GameStop is still a bad long-term wager. Who cares about the 5% yield? GameStop would have to be around another 20 years paying that same rate for investors to make back their money if the retailer goes kaput. Do you really think GameStop will be around in 20 years?

Karimzad may be right about a bounce in the near term. No stock goes to zero in a straight line. However, it's hard to get excited about a retailer when its story gets uglier with every passing quarter. The analyst doesn't see it that way. He's calling for a profit of $3.16 a share this year, $3.82 a share in 2013, and $4.27 a share come 2014.

Really? Keep in mind that GameStop's own guidance for comps this year has gone from as high as 5% back in March to as low as negative 10% just last month. This is a market deteriorating quickly, and it's not as if new consoles will help bring casual gamers back to physical purchases.

GameStop may rally from here, perhaps even hitting Karimzad's target, but the long-term direction of the stock is still south until GameStop proves that it can revive the gloomy store-level sales trend.

Digital future
Even though the next trillion-dollar revolution will be in mobile, it may not involve GameStop's digital initiatives. A free special report will get you up to speed.

The Motley Fool owns shares of Best Buy, RadioShack, and GameStop. Motley Fool newsletter services have recommended creating a modified stock repair position in GameStop. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Longtime Fool contributor Rick Munarriz calls them as he sees them. He does not own shares in any of the stocks in this story. Rick is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early.

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