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%

6.4%

Fail

 

1-year revenue growth > 12%

(7.9%)

Fail

Margins

Gross margin > 35%

29.4%

Fail

 

Net margin > 15%

(4%)

Fail

Balance sheet

Debt to equity < 50%

0%

Pass

 

Current ratio > 1.3

1.07

Fail

Opportunities

Return on equity > 15%

(14.1%)

Fail

Valuation

Normalized P/E < 20

8.72

Pass

Dividends

Current yield > 2%

4%

Pass

 

5-year dividend growth > 10%

NM

NM

       
 

Total score

 

3 out of 9

Source: S&P Capital IQ. NM = not meaningful; GameStop paid its first dividend in Feb. 2012. Total score = number of passes.

Since we looked at GameStop last year, the company has kept its three-point score for the third year in a row, with revenue growth slowing but the game retailer starting to pay a dividend. The stock has been volatile but has managed to climb by about 10% over the past year.

The video game industry has had a lot of trouble recently, and with GameStop's reliance on a healthy video game market, the retailer hasn't had the most promising financial results. Early last month, the company said that comparable-store sales fell 4.4% in November and December, traditionally hot months for the business. Given that Activision Blizzard (NASDAQ: ATVI  ) set new sales records with its "Call of Duty: Black Ops II" release and that Nintendo had a new game console available, the fact that GameStop nevertheless saw hardware and software sales fall substantially was particularly disappointing.

But the bigger concern has to come from general weakness among the game makers that supply GameStop with products to sell. Electronic Arts (NASDAQ: EA  ) posted much lower revenue in its most recent quarter, with particular weakness in physical game sales as the company was able to boost digital revenue modestly. Meanwhile, Take-Two Interactive (NASDAQ: TTWO  ) pushed back its "Grand Theft Auto V" release to this fall, months beyond where investors were hoping to see the game.

Moreover, the digital distribution trend threatens to cut GameStop out entirely. As a middleman, GameStop relies on physical games to resell -- something that could disappear if game makers are able to sell directly to customers without a retailer go-between.

For GameStop to improve, it needs to find a way to keep up with changing dynamics in the video game industry. Otherwise, it could be doomed to flounder as an obsolete antique.

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.

With GameStop's woes, one of the more interesting plays on the video game sector right now is Electronic Arts. Find out all about how EA plans to dominate the industry in our premium research report on the stock, which breaks down the risks and opportunities facing the company to help you decide if EA is right for your portfolio. Click here to get your copy now and we'll throw in a year of free quarterly updates as news breaks.

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


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