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Is GameStop Stock a Buy Ahead of New Game Console Launches?

By Keith Noonan – Jun 18, 2020 at 10:29AM

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The video game retailer's stock looks attractive by some metrics, but the full story is complicated.

GameStop (GME 4.70%) stock has lost roughly 90% of its value over the last five years and trades near lifetime lows. The brick-and-mortar retailer has been hit hard amid rapid growth for digital software distribution and a series of failed diversification ventures, and it's not clear that the business has a long-term future. 

But the company's business and its stock performance have also tended to be somewhat cyclical and have enjoyed tailwinds from the launches of new video game platforms. With new console hardware from Sony (SONY -1.44%) and Microsoft (MSFT -0.92%) due for release at the end of this year, is there hidden opportunity in GameStop's beaten-down stock?

Sony's PlayStation 5 console and controller.

Sony's PlayStation 5 console. Image source: Sony.

A brief history of GameStop stock and console launches

For a better understanding of why some investors and analysts might espouse a bullish case for GameStop despite the long-term hurdles the business faces, it helps to look at the stock's performance in relation to major launches of video game hardware. The chart below tracks the stock's performance since the company's initial public offering in February 2002:

GME Chart

GME data by YCharts.

Microsoft's Xbox 360 console was launched in November 2005, while Sony's PlayStation 3 and Nintendo's (NTDOY 0.58%) Wii consoles came out the next year. GameStop's share price hit its all-time high in late 2007, buoyed by strong sales for software and hardware (including Nintendo's DS portable platform) and an encouraging outlook for the broader industry driven by booming interest in hard-core and casual gaming.

Shares then took a big hit amid 2008's stock market crash and didn't see much recovery until the PlayStation 4 and Xbox One consoles were on the horizon. GameStop stock would go on to hit its highest price over the last decade on November 2013, the same month that PlayStation 4 and Xbox One were launched.

Momentum from the new console cycle helped keep the stock relatively elevated for a couple of years, but rapid growth for digital game sales and weakened performance for GameStop's mobile phone and nongaming tech hardware businesses eventually crushed its valuation.

The last hit console didn't save GameStop

GameStop stock has typically posted its best performance when successful new consoles are relatively early in their life cycles, and hardware and software from the previous generation are still serving as meaningful business contributors. A hit new console hasn't always driven strong performance for the company's overall business or stock, however.

Nintendo's Switch was launched in March 2017 and has posted fantastic hardware and software sales. It's also likely seen a higher percentage of games sold on physical media compared with PlayStation 4 and Xbox One because it has much less storage space for downloads. But GameStop stock has slumped 81% since the launch of the hugely successful Switch.

Nintendo's Switch console.

Nintendo's Switch console. Image source: Nintendo.

Software is the (sputtering) heart of the business

The collapse of GameStop's mobile and nongaming tech hardware businesses partly explains the stock's poor performance amid huge success for the Switch, as does the suspension of the retailer's once-generous dividend. But digital game distribution eating away at the company's sales of new and used games is the biggest overall factor in the stock's decline. A console sales boom alone won't save GameStop.

The company's revenue will likely soar in the fourth quarter thanks to the launch of new consoles from Sony and Microsoft. Sales tailwinds should continue through the next fiscal year as well. Unfortunately, the retailer nets slim margins on console hardware units, so the new gaming systems themselves won't do much for its sagging bottom line. 

GameStop gets better profit margins on used game sales than on any other category of products. Shoppers can trade in their titles for cash or store credits, and the retailer then resells those titles at a markup. While the company's new-games business has been hit hard by digital distribution trends, players opting for downloads instead of physical media is crushing its used-games business. 

GameStop looks quite cheap on a (flawed) fundamental basis

GameStop ended the first quarter with $570 million in cash against debt of $417.2 million, though the company has said it began looking for additional loans at the beginning of June. Even so, lots of companies are looking to secure additional funding right now, and having $153 million in cash and short-term assets net of debt at the end of last quarter could be appealing considering that the company is valued at approximately $300 million.

A massive string of write-offs and impairments has already taken place over the last few years. The unadjusted bottom-line results across the stretch are dreadful, but investors are tasked with valuing the business based on its future.

With the company's nongaming tech hardware business having been cast off and GameStop's book value sitting at just $435 million, it's reasonable to expect that the worst of the big writedowns and impairment charges are in the rearview mirror. Additional charges will probably occur, but there simply isn't room for the type of writedown and impairment impacts that have occurred over the last few years. At the same time, that doesn't mean the company makes a lick of sense as a long-term investment. 

Microsoft's Xbox Series X controller and controller.

Microsoft's Xbox Series X console; Image source: Microsoft.

 

GameStop probably won't be around a decade from now

Investors looking for beaten-down stocks with short-term rebound potential can make a solid case that GameStop shares will spike when the new console cycle injects some life back into the business. The company has a price-to-book value of just 0.7 and trades at roughly 0.05 times this year's expected sales.

But the long-term outlook is as bad as it has ever been, and there are no meaningful signs of progress on the fundamental issues facing the business. As tempting as some of the valuation metrics might look in the context of a potential cyclical uptick, there are much better plays in the gaming space. Long-term investors should continue to avoid GameStop. 

Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Keith Noonan has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Microsoft. The Motley Fool recommends Nintendo and recommends the following options: long January 2021 $85 calls on Microsoft and short January 2021 $115 calls on Microsoft. The Motley Fool has a disclosure policy.

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Stocks Mentioned

GameStop Corp. Stock Quote
GameStop Corp.
GME
$25.63 (4.70%) $1.15
Microsoft Corporation Stock Quote
Microsoft Corporation
MSFT
$235.26 (-0.92%) $-2.19
Sony Corporation Stock Quote
Sony Corporation
SONY
$65.74 (-1.44%) $0.96
Nintendo Co., Ltd. Stock Quote
Nintendo Co., Ltd.
NTDOY
$51.82 (0.58%) $0.30

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