GameStop (GME 2.56%) has been all over the news lately as a Reddit group, WallStreetBets, touted the stock. As GameStop's share price has shot up, short-sellers have scrambled to purchase the shares, creating a short squeeze, contributing to the increase.
It is easy to get swept up in the rapid price increase and jump in due to a fear of missing out. I urge you to refrain from doing so since it is likely to end up costing you a lot of money.
Image source: Getty Images.
A crazy valuation
The stock started the year at about $17 and zoomed up to $483, with most of that move happening in the last few days. That stock price gave GameStop a market capitalization of $31.5 billion. Even with the recent pullback, it is still around $13.5 billion. What happened recently that made the company worth 15 times what it was at the start of the year?
The answer is very little. A couple of weeks ago, GameStop reached an agreement with activist investor RC Ventures to put three new directors on the board. It has been pushing management to close underperforming stores and concentrate on e-commerce initiatives such as a greater online presence with faster shipping. Customers would be allowed to trade in goods online, and streaming would increase.
This shift sounds reasonable, but executing the plan will prove challenging. It's certainly no reason to pile in, particularly after the stock's huge run.
Major issues remain
After all, there are a host of companies that offer online games. Sony's (SONY -0.33%) new PlayStation has a version without a disc drive and Microsoft (MSFT -2.45%) already had an all-digital Xbox.
The good news is that customers turned to GameStop to buy the new PlayStation and Xbox consoles, helping boost its nine-week same-store sales (comps) ending on Jan. 4 for a 4.8% increase. However, with many companies offering digital games, including Sony, Microsoft, Epic Games, and Steam, GameStop's software business will face strong competitive challenges.
Before that, its sales were struggling. The company's third-quarter same-store sales (comps) fell by 24.6%. While the pandemic hurt results, these were weak even before COVID-19 affected operations. GameStop's 2018 comps fell by 0.3% and were down by 19.4% the following year.
When investors start hyping a stock, it is difficult to remove emotions from the equation. But that is what's required to save yourself from heartache and big losses. Apart from the holiday season, GameStop's comps and profitability have been faltering. After all, activist investors typically don't get involved if everything is going well.
Investing is a serious business, but this has the classic underpinnings of people playing a game that is going to end badly. To avoid getting burned, this is one stock you shouldn't play around with right now.
