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1 Stock to Avoid No Matter What

By Lawrence Rothman, CFA - Jun 16, 2021 at 11:45AM

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This company faces an uphill climb to turning things around.

GameStop (GME 8.32%) has certainly had a wild ride this year. If you owned the stock coming into 2021, it was a lot of fun watching the per-share price go from about $17 to the current $212.

But you shouldn't get lulled into buying the hype surrounding this meme stock. The run was partly fueled by a Reddit group, which promoted the stock and also created a short squeeze that led the price higher. That makes for great headlines, but there are strong reasons to avoid getting pulled in.

Trying to transition

GameStop, which sells video game consoles and software, was already experiencing weakening sales heading into 2020. Same-store sales (comps) fell by 19.4% in 2019, following that up with a 9.5% drop last year.

Two kids sitting together, with one wearing a virtual reality headset.

Image source: Getty Images.

While the company was experiencing strong sales growth for a long time, the last few years have been rough. It posted negative comps in four out of the last five years. That's due in no small part to a world that is changing, and people can increasingly download games from a variety of reputable companies such as Epic Games, Steam, Microsoft, and Sony.

A major investor saw an opportunity to turn around GameStop's fortunes. RC Ventures, headed by Ryan Cohen, founder of the online company Chewy, built a 13% ownership in the company. He is now chairman of GameStop and has made key management changes, including hiring a new CEO and CFO who previously worked for Amazon.

Clearly, Cohen has committed his financial resources and time to making GameStop successful. While he built up impressive credentials at Chewy, which PetSmart bought for $3.4 billion (and still owns a majority stake in despite taking the company public), can he work his magic this time around?

Don't get fooled

It's a tough road to get GameStop moving in the right direction. Management didn't provide a comparable sales figure, but the fiscal first quarter's top line did increase by better than 25% to $1.3 billion for the period ended on May 1. But you shouldn't get overly excited by this impressive headline figure.

It is difficult to make year-over-year comparisons since the company cut its store base by 12%. While this would make the sales growth seem more impressive, remember, GameStop was forced to close stores last year due to the pandemic. So this depressed the year-ago figure. Then, the current period benefited from Sony and Microsoft releasing new game consoles last year. This will prove to be a temporary lift since it's a one-time purchase.

The company will need to follow this up with improved game sales. However, software sales were down during the period. While the company blamed this on lower used game inventory, it has gotten a boost in the past when companies released new systems. This suggests that GameStop's hope for a multi-year bounce from the new systems is already facing hurdles.

Details lacking

While the new management team has online e-commerce experience, details on a plan forward remain lacking. Undoubtedly, that is coming as the executives meet and figure out where they want to go. However, with stiff online competition, it is tough to invest in the company without knowing how it will turn itself around and get sales back to sustained profitability.

That's why you should leave GameStop's shares on the shelf.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. Lawrence Rothman, CFA has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon and Microsoft. The Motley Fool recommends Chewy, Inc. and recommends the following options: long January 2022 $1,920 calls on Amazon and short January 2022 $1,940 calls on Amazon. The Motley Fool has a disclosure policy.

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