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Should You Buy Into the GameStop Hype?

By Parkev Tatevosian - Jan 28, 2021 at 10:42AM

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Shares of the videogame retailer are on a meteoric rise.

GameStop's (GME 9.35%) share price is up over 670% in the last five days alone. Fueling the rise is a group of individual traders who use social media sites like Reddit, Discord, Facebook, and Twitter to discuss opportunities to profit in the stock market. Still, volatility in the stock is also extreme, and it can be hazardous for someone trying to buy and sell it with the hopes of short-term gains. As Andrew Left of Citron Research accurately describes it, "It's just a get-rich-quick scheme."

Undoubtedly, many are profiting tremendously from the rapid rise in its share price, but should you buy into the GameStop hype

A chart showing the rapid rise of GameStop stock price.

Data source: YCharts.

What will the future hold for GameStop?

Ultimately, GameStop is a retailer that gets a significant portion of its revenue from the sale of physical copies of video games in a world where sales are transitioning to digital versions. Still, there is a group of the most active gamers who prefer physical copies. That's because a physical copy of a game can be re-sold after one is finished or bored with a certain game. The same cannot be done with a digital copy. Until this point, game developers are not offering digital games at much of a discount compared to their physical counterparts. As long as this dynamic exists, GameStop is a viable company with a sustainable business model. 

However, that may not be enough to justify having 5,000 stores across 10 countries as GameStop does. Indeed, the company is already well into its plan of what it calls de-densification, which basically means that it's reducing the number of locations in operation. 

Stock chart and rising arrow in front of world map

GameStop shares are on a meteoric rise. Image source: Getty Images.

The recent launches of intensely popular next-gen gaming consoles from Sony and Microsoft make GameStop management confident that sales will get a boost in 2021 and beyond. Still, over the last decade, revenue has decreased for GameStop at a compounded annual rate of 3.3%. And while it may get a boost in sales from next-gen consoles and games, it may not be enough to offset declines from sales moving to digital channels. Even if it did turn around sales growth from negative to positive, the gains are likely to be modest.

What about GameStop's valuation? 

A chart comparing valuation of GameStop stock versus Amazon's stock.

Data source: YCharts.

The rise in its share price is leading GameStop's stock to be trading at astronomical valuations. For instance, GameStop is trading at a forward price-to-sales ratio of 4.4 as of this writing. Comparatively, Amazon is selling at a forward price-to-sales of 3.6. Admittedly, this is not an apples-to-apples comparison, but it just goes to demonstrate that GameStop's valuation is getting expensive. And it would be hard to argue the merits of a valuation for GameStop that surpasses that of Amazon.

That being said, no law says the stock price cannot remain elevated. However, as a long-term investor, it is prudent to weigh a company's prospects and valuation and compare it to other opportunities you have with your hard-earned money. And from that perspective, it does not make sense to buy into the GameStop stock hype. 

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