Why I'm Not Buying GameStop

In past decade, bookstores, record shops, video rental shops have virtually disappeared -- driven out business by Amazon.com, Apple, Netflix, etc. Only one form of popular media is still widely sold in dedicated, physical stores: video games. That business is dominated by GameStop (NYSE: GME  ) , which has proven to be a savvy operator. Its stock has returned more than 80% this year, and investors are excited about the recent releases of the PlayStation 4 and Xbox One consoles.

However, it's one stock that I wouldn't touch. Digital downloading of games is on the rise and eventually GameStop's stores and used-game business will become obsolete. As a result, the company's intrinsic value is likely significantly below today's trading price.

Why I'm not buying GameStop
It's taking longer than expected, but eventually game distribution will be fully digital -- a cheaper, more efficient distribution model with potential benefits for both video game makers and players. The shift is already happening. According to a report by the NPD Group, digital game sales surpassed physical game sales last quarter. Last quarter, Electronic Arts (NASDAQ: EA  ) and Activision Blizzard (NASDAQ: ATVI  )  respectively generated 65% and 59% of revenue from digital channels.

The only question is how long it takes for the industry to completely transition to digital distribution. My best guess is that it will probably happen within the next 10 years. That will cause GameStop's profits from new and used games to evaporate. Unless management miraculously transforms the company's business model, GameStop will cease to exist.

Based on my investment approach, that's a total deal breaker. My goal in buying a stock is hold it for a very long time -- five years, 10 years, or even longer -- and I evaluate stocks solely based on the future profits they can generate relative to my purchase price. GameStop is trading at 14-times earnings today, with a 2.2% dividend. If the company is likely to fail within the next 10 or even 15 years, it's impossible to justify buying at today's price based on that criteria.

Foolish takeaway
I don't know how GameStop's stock will trade over the next quarter or even the next few years. But over a longer period of three, five, or 10 years, I'd be very surprised if investors made a profit. 

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Read/Post Comments (3) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 11, 2013, at 9:18 PM, TMFWillSommers wrote:

    Hi freejazz38 -

    Thanks for reading the article. My conclusions on GameStop are based my best estimation of the future business conditions, along with my approach to investing (I tried to indicate that in the article). You should feel free to disagree with both my future projections and investing style.

    However, just because you disagree with this article on GameStop, doesn't mean that I'm a moron or that everyone at the Motley Fool is a know-nothing.

    I have made hundreds of bearish/bullish calls on stocks in Motley Fool CAPS, which are all tracked going back to 2006. I've made plenty of wrong calls and mistakes, but overall I've picked more winners than losers, and I'm ranked in the top ~1% of nearly 76,000 players . While it's definitive proof, it's a strong indication that I'm not a moron. You can review my record by searching for TMFWillSommers on http://caps.fool.com/. I've recorded my bearish call GameStop in CAPS. I can guarantee whether I'm right or wrong, but the result will be tracked and transparent.

    Also, the Motley Fool doesn't represent a single opinion on any stock. We encourage independent thought, open debate, and "Motley-ness" among out analysts and contributors. I'm bearish on GameStop, but other Fools disagree. Check out these articles that are bullish:

    http://www.fool.com/investing/general/2013/12/07/5-reasons-w...

    http://www.fool.com/investing/general/2013/12/05/roundtable-...

    http://www.fool.com/investing/general/2013/12/04/2-companies...

    I hope that's helped clear up any confusion.

    Fool on!

    Brendan

  • Report this Comment On December 13, 2013, at 11:27 PM, TMFWillSommers wrote:

    Hi freejazz38 -

    What do you think are the top 3 things that I got wrong in my article? Or what do you think are the top 3 reasons to invest in GameStop?

    I appreciate you passion for the stock, and I enjoy learning from others that have different opinions.

    Stay Foolish

    Brendan

  • Report this Comment On December 17, 2013, at 3:16 PM, guardbear wrote:

    The consumer's ability to buy and sell used games and systems is something that cannot be duplicated by the digital marketplace.

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