Traders who were fortunate enough to get in the meme stock mania early could have made astronomical returns on GameStop (GME 6.16%) stock. The price has more than halved from January, but GameStop stock is still up over 700% on the year in 2021.
Note, however, that the rise was not due to an improving business. On the contrary, losses continue to mount for the game retailer. GameStop has poor business prospects and has yet to prove it can return to profitability. Here are three reasons investors should steer clear of GameStop stock.
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1. The company's mounting operating losses
In GameStop's first three quarters of 2021, it lost $234 million on the bottom line. That's after it lost $296 million during the same time the prior year. GameStop operates brick-and-mortar retail stores that sell video games, consoles, and accessories. Folks were visiting stores less often even before the outbreak, and now that a potentially deadly virus is in circulation, store traffic is down considerably. Meanwhile, rent and lease payments are due every month regardless of how many customers are visiting the stores.
Similarly, during the first three quarters of 2021, GameStop lost $324 million in cash from operations. That's significantly higher than the $41 million it lost in cash from operations in the same period of 2020.
The losses are not all due to the effects of the coronavirus pandemic. GameStop reported losses in 2019 as well.
2. Poor positioning with adverse industry trends
As I mentioned earlier, GameStop operates brick-and-mortar stores. However, consumers are increasingly moving their spending to e-commerce channels. GameStop has a website, too, but the expenses generated by its thousands of brick-and-mortar stores are weighing on its operating performance.
Moreover, GameStop's business model is based on selling physical copies of games. GameStop is on the wrong side of that trend, too. Video games for computers and consoles are available for download. Customers have a choice of driving or walking to the closest GameStop or another video game retailer to buy a copy, or buying the game, downloading it, and starting to play in less time than it would take to go to the nearest store. That convenience advantage is unlikely to reverse.
Indeed, these two trends are the leading causes for GameStop's revenue declining at a compounded annual rate of 6% in the last decade.
3. A stock that's too expensive
GameStop's astronomical stock price increase has its shares trading at unreasonably high levels. Before the meme stock frenzy, GameStop's stock had not traded above $100 in the last decade. As of this writing, GameStop is selling for $154.
Worse still, the business is in a fundamentally weaker position than it was at any time before the outbreak. The mismatch between business and stock price performance is another reason investors should steer clear of GameStop stock.
