Shares of gaming retailer GameStop (NYSE: GME) resembled nothing so much as a game of Pong this week, only rotated 90 degrees.
They popped in response to Tuesday's "earnings beat," then dropped back with the rest of the market on Wednesday, only to surge even higher today -- helped, no doubt, by bullish remarks from Zacks.com. According to Zacks, this Motley Fool Stock Advisor recommendation will be worth $65 a share by September, making for a 30% return in six months' time. Nice to hear, but what's the basis for the bullishness?
Big picture
Let's skip right past the quarterly news, which basically followed the usual pattern -- management underpromised, management overdelivered, par for the course. You can read all about that in the mainstream press. Today, I'd rather focus on the firm's annual performance.
We saw GameStop deliver 33% sales growth in 2007, and transform that into 82% improvement in earnings. That made for $1.75 per share under GAAP -- no clue how much cash the firm generated, though. Management didn't bother to include a cash flow statement with its earnings release, and has not yet filed its 10-K (but I'll update you on these numbers in our next Foolish Forecast).
Looking out further still, GameStop gave us superb visibility into its expectations going forward, providing guidance not just for this year, but the next as well. CEO Richard Fontaine crowed over his firm's "record" hardware sales and the "all-time high" in the "installed base of users" (i.e., people who have already bought their Microsoft (Nasdaq: MSFT) Xbox 360s, Nintendo (OTC: NTDOY) Wiis, and Sony (NYSE: SNE) Playstation 3s), and who are therefore now able to spend even more money on software titles from Take-Two (Nasdaq: TTWO) and Activision (Nasdaq: ATVI).
With this groundwork complete, GameStop predicts it will earn as much as $2.34 per share this year, and somewhere in the neighborhood of $3 per share in 2009. If it hits those numbers, we're looking at at least 25% annual earnings growth for the next two years.
Foolish takeaway
Of course, two years from now, the current product cycle in gaming will already be looking a bit long in the tooth. Earnings growth of 25% may be achievable this year and the next, but by 2010, I have to wonder whether it will be time for things to start slowing down again, as gamers start saving their pennies to buy the new Microsoft Xbox 720, Playstation 4, and Nintendo Us-Vs.-Them (I'm guessing at the new console names, of course).
Assume, though, that GameStop does earn $3 a share in 2009. Assume further that investors are willing to give it, say, a 25 multiple to earnings in two years' time. That would make this stock worth about $75 two years from now -- 50% higher than where it sits today. Seems to me that Zacks' prediction of $65 a share in late '08 isn't too much of a stretch.
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