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Why You Should Avoid GameStop Stock

By Bradley Freeman - Jun 2, 2021 at 7:50AM

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This company's future is not as bright as its stock price indicates.

In the last 12 months, GameStop (GME 3.91%) stock has risen over 5,000% to reach $17 billion in market capitalization. The rise seems to be predominately driven by a short squeeze rather than by fundamentals involving shrinking revenues and compressing margins.

If you look at social media, I'm sure you can find passionate people telling you why to invest in the company. While it may be tempting to hop on the GameStop bandwagon to claim your piece of the profits, I really wouldn't. Here's why:

Two people sitting on a couch and playing video games

Image source: Getty Images.

Gaming console threats

GameStop is attempting to transform itself into an e-commerce company to keep up with the times, but the success of that transformation is far from a sure thing. More and more, console makers like Microsoft and Sony are working with content creators like Electronic Arts to offer games and subscriptions directly through Xbox and PlayStation. This makes GameStop's core brick-and-mortar business significantly less durable.

GameStop does not need to exist in this equation. The company has virtually zero hardware or content intellectual property (IP) to ensure its place in the evolving supply chain, and that place is becoming more precarious by the year. Parties with IP ownership can juice their margins by attempting to vertically integrate GameStop out of their business -- and that is now happening.

This is not just a win for GameStop's competition but for consumers as well. We can now purchase and play games all in one place, which offers a new layer of convenience GameStop cannot yet match.

Furthermore, Sony and Microsoft are not just pursuing direct-to-consumer channels more aggressively but also have rolled out digital-only consoles without a slot to insert a game disk. As a reminder, GameStop's store walls are covered in game disks and consoles. These deep-pocketed companies have the IP to be able to pull this off, and there's no guarantee future consoles will even offer a version with a disk slot.

With roughly 50% of GameStop revenue coming from hardware sales, this could be worrisome down the road.

Content creator revenue shift

For video game creators specifically, in-game purchases are becoming a relied-upon driver of growth. Buying a new digital wardrobe on Microsoft's Minecraft (as silly as it sounds to some) is now a common occurrence.

GameStop is not able to enjoy any of the upside from this segment, and that's certainly not ideal. For context, in-game purchases are set to expand at a brisk 19.8% annual growth rate through 2027 to reach $340.7 billion in annual sales for the gaming industry as a whole.

So what is next? 

At this point I think the company will need to purchase IP content rights in order to ingrain itself in the quickly changing video game landscape. Fortunately for the company, it has a substantial cash balance to do so, but that's partially thanks to some shareholder dilution and some expensive debt it recently raised. Encouragingly, it has compelling board representation from Chewy's former founder, who certainly has experience in building a digital powerhouse.

Still, why should investors take a gamble that depends on whether this company can transform itself quickly and effectively enough? There are much stronger and safer plays in this compelling sector that have earned our interest thanks to years of execution. When we can pick from iconic enterprises like Nintendo or young, thriving creators like Roblox Corporation, places like those are where I feel our investment dollars would be better spent.

Avoid GameStop for now

We can always check back in on a company every few months to see if things have changed. As of now GameStop offers far more potential risk and headache than upside. For this reason I think everyone should steer clear and invest elsewhere.

Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Bradley Freeman owns shares of Microsoft. The Motley Fool owns shares of and recommends Microsoft. The Motley Fool recommends Chewy, Inc., Electronic Arts, and Nintendo. The Motley Fool has a disclosure policy.

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Stocks Mentioned

GameStop Corp. Stock Quote
GameStop Corp.
GME
$40.99 (3.91%) $1.54
Microsoft Corporation Stock Quote
Microsoft Corporation
MSFT
$289.50 (0.86%) $2.48
Electronic Arts Inc. Stock Quote
Electronic Arts Inc.
EA
$130.82 (0.88%) $1.15
Sony Corporation Stock Quote
Sony Corporation
SONY
$86.13 (0.36%) $0.31
Nintendo Co., Ltd. Stock Quote
Nintendo Co., Ltd.
NTDOY
$53.65 (-0.55%) $0.29
Chewy, Inc. Stock Quote
Chewy, Inc.
CHWY
$49.17 (1.80%) $0.87
Roblox Corporation Stock Quote
Roblox Corporation
RBLX
$50.57 (2.04%) $1.01

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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