On Tuesday, before GameStop (NYSE:GME) reported its third-quarter results, shares of the video game retailer looked awfully cheap. The company had guided for full-year adjusted earnings per share between $1.15 and $1.30 just three months ago, putting the price-to-earnings ratio barely above 5.

The stock would have been cheap if those earnings were sustainable, but valuation metrics mean little when the denominator is in free fall. Today, after GameStop's disastrous third-quarter report, the stock doesn't look so cheap anymore.

GameStop now expects to produce adjusted earnings per share between just $0.10 and $0.20 this year, 88% lower at the midpoint than the previous guidance. The price-to-earnings ratio based on this new outlook is nearly 40. GameStop is definitely not a value stock.

A man in a plaid shirt with his hands on his head and screaming.

Image source: Getty Images.

What happened?

GameStop's third quarter was just about a catastrophe. Comparable sales crashed 23.2% year over year, driving total revenue down 25.7%. New hardware sales tumbled 45.8%, new software sales slumped 32.6%, and accessories sales declined 13.4%. GameStop's revenue of $1.44 billion missed analyst estimates by $180 million.

Not all of this is GameStop's fault. Both Sony and Microsoft will be launching new game consoles next year, so demand for the current game consoles is lagging. Solid sales of the Nintendo Switch picked up some of the slack but wasn't enough to prevent a steep sales decline.

While the slump in demand wasn't a surprise, the company was caught off guard by the severity of the downturn. "Our third quarter results continue to reflect the prevailing industry trends, most notably the unprecedented decline in new hardware sales seen across the market as the current generation of gaming consoles reach the end of their lifecycle and consumers delay their spending in anticipation of new hardware releases," said GameStop CEO George Sherman.

Beyond sales of new products, GameStop's lucrative used-games business continues to falter. Pre-owned and value video game products saw sales slip 13.3% year over year, adding to a long streak of declining revenue. The business has been in decline since the beginning of 2016, and the rate of that decline is accelerating as the current console generation comes to an end.

Other than digital games, used games carry the highest gross margin of any segment for GameStop, nearly double that of new games and nearly quadruple that of new hardware. As the used-games business goes, so goes GameStop.

GameStop's plan is to cut costs and buy back a ton of its own shares. The company has spent $178.6 million buying back 34% of its outstanding shares this year, knocking down the share count to boost per-share earnings. Unfortunately, the bottom line is collapsing too quickly for the effort to work.

The future looks bleak

GameStop will get a boost next year when the new game consoles launch, but in the long run, it's difficult to imagine a scenario where a nationwide retailer of physical video games can survive. Just like PC games did years ago, console games are going digital. Downloads and perhaps streaming services will only become more popular, at the expense of physical game discs.

There's no such thing as a used digital game, so GameStop's used-games business is effectively doomed. It's a huge source of profits for the company, responsible for a third of its gross profit in the third quarter.

Value investing is not just buying stocks with low price-to-earnings ratios. When earnings are imploding, valuation metrics based on the current numbers are meaningless. GameStop must be valued based on its future potential, and right now, it doesn't appear to have much at all.