Shares of GameStop (NYSE:GME) were down more than 10% on Sept. 11, the day after the retailer reported a second-quarter adjusted loss of $0.32 a share. That was $0.10 worse than Wall Street's consensus and more than triple last year's loss for the same period. Year-to-date, the stock has plummeted over 64%, and this weak performance follows management's decision to eliminate the quarterly dividend back in Q1.

Despite the appalling year-to-date performance and lack of a dividend, there are reasons to believe strongly in GameStop's potential.

Shopping basket full of video game accessories

Image source: Getty Images.

Boss battle 

Concerns about an imminent worldwide recession have decreased with the cooling off of the trade war with China. As a result, risk-tolerant investors are beginning to nibble on stocks that have been severely punished in the recent past. Even in light of disappointing earnings, GameStop's stock price is up 40% since its August lows.

And the company has a very healthy cash reserve, with shareholder activism increasing pressure for aggressive stock buybacks. The prospect of this alone could send the stock price up, no matter what happens in the near term.

That said, the former hub for all things gaming has lost legions of customers to the expanding digital market. Consumers like the convenience of buying games in the digital marketplace, as well as the enticing subscription-based memberships, free games, and discounts it makes available.

As for consoles, hardware sales made up 15% of total company revenue last quarter, down a whopping 41% year over year. This probably won't improve anytime soon; Sony's (NYSE:SNE) latest PlayStation and Microsoft's (NASDAQ:MSFT) refreshed Xbox model most likely won't be launched until late 2020 or maybe even 2021.

Division Fiscal Second-Quarter 2019 Fiscal First-Quarter 2018 Year-Over-Year Difference
Software $285.0 $300.9 (5.3%)
Pre-owned $373.1 $452.1 (17.5%)
Hardware $175.6 $298.3 (41.1%)
Accessories $169.6 $187.3 (9.5%)
Collectibles $171.8 $141.7 21.2%
Others $110.6 $120.8 (8.4%)

Source: DM Martins Research, using data from company reports. Numbers in millions, except year-over-year difference.

Death match with reality

Guidance for the rest of 2019 was far below Wall Street's consensus, with management projecting full-year earnings of $1.15 to $1.30 per share and comparable-store sales declining at a rate in the "low teens" after slumping 11.6% over the past quarter.

"Make no mistake, this transition will take time and our sales expectations over the next several quarters will reflect the end of the console cycle and the next generation of consoles later in 2020," GameStop CEO George Sherman told investors on a conference call as he outlined the company's turnaround plans. "However, our strategic framework is focused not only on sales, but expanding our gross margin, reducing costs and optimizing inventory management, all of which will lead to continued growth of free cash flow of the business, both in the near term and over the long term."

The good news is that GameStop has $424 million of cash on its balance sheet, almost entirely offset by $419 million in long-term debt. Importantly, that's long-term debt -- creditors are not demanding to be paid.

And the company's turnaround strategy is under way, with 200 store closures so far, layoffs, and discounting of old inventory. Management is focusing on beefing up their digital offerings with an updated online platform. And with 5,800 store locations in 14 countries, management is also intent on creating social and cultural hubs to attract gamers into the stores, much like the video arcades of the past.

GameStop stock could be volatile in either direction right now, so only the most risk-tolerant investors should commit at this time. The situation will become more clear when Sony and Microsoft release their new gaming consoles.

Consoles are developed in seven-year cycles, and we're currently at the end of one. That means gamers have delayed purchases of Sony and Microsoft consoles because the current models are considered outdated, lacking exciting new virtual reality, augmented reality, and other desirable features. Console growth through 2023 is forecast at 4% in addition to pent-up replacement demand, so investors should watch for GameStop's financials to improve significantly as gamers rush to get the latest and greatest machines in late 2020 or early 2021.