You may not know it from this morning's mixed quarterly report, but GameStop (NYSE:GME) is shrinking before our very eyes.

The video game retailer posted uninspiring results in its third quarter. Sales fell 9% to $1.77 billion, bogged down by an 8.3% slide in comparable-store sales. Even the sale of pre-owned games and gear -- a high-margin category that has served the small-box chain well over the years -- isn't there for GameStop anymore. An 8.9% slide in that category, while holding up better than doubled-digit plungers in new hardware and software, matches GameStop's global top-line decline.

Things get uglier as you work your way down the income statement. After backing out a huge impairment hit, adjusted net income slipped 12% to $47.2 million.

The Illusionist
Here's where the sleight-of-hand starts to get crafty. GameStop's adjusted profit of $0.38 a share is well ahead of the $0.33 a share that Wall Street was targeting, but it's just short of the $0.39 a share it posted a year earlier. How can the year-over-year decline be so small? Well, GameStop has been aggressively buying back its stock over the past three years.

GameStop snapped up 3.7 million shares during the quarter, and it has repurchased $1 billion worth of stock since 2009. There are now 12% fewer fully diluted shares outstanding than there were a year ago in calculating the chain's adjusted earnings. Fewer shares mean a lower denominator when profitability is the numerator, inflating income on a per-share basis.

There's nothing wrong with using bountiful cash to retire stock. It's a practice that's applause-worthy as long as the company has the financial fortitude to pull it off. It also helps if it doesn't wind up overpaying for the stock in retrospect, the way that Netflix (NASDAQ:NFLX) did last year. The video service shelled out $200 million to buy its stock during the first nine months of last year at an average price of $221 per share. Those purchases struck out on both ends of the sniff test. Netflix shares are now in the double digits, and the company had to raise money late last year (at lower price points).

GameStop isn't there, yet.

Some of the shares gobbled up during its heyday came at higher price points, but the stock is currently higher than its most recent purchases. GameStop's cash and equivalents has declined from $442.6 million to $366.4 million over the past year, but there's no danger of it having to panhandle anytime soon. The model is still oozing buckets of greenbacks, even as the long-term outlook for a bricks-and-mortar retailer is bleak at best.

The Prestige
GameStop can continue to buy its way out of bottom-line disappointments, for now. The one thing that it can't disguise is that folks just aren't buying games and gear the way that they used to.

The chain has actually lowered its comps guidance for 2012 after each and every quarterly report. It's happening again today, going by the midpoint of its outlook.


Comps for 2012


Q4 2011

1% to 5%


Q1 2012

(5%) to 0%


Q2 2012

(2%) to (10%)


Q3 2012

(6%) to (9%)


Source: GameStop quarterly reports.

October was brutal for the video game sector. Industry tracker NPD Group reported that domestic retail sales of new video game products tanked 25% last month.

November will be better. Way better. Activision Blizzard (NASDAQ: ATVI) likely set records with Tuesday's release of Call of Duty: Black Ops II. GameStop held midnight openings on Monday night to arm fans of the combat game with early copies.

Sunday will also be important. Nintendo (OTC:NTDOY) introduces the Wii U, the industry's first new gaming console in years. GameStop specifically singled out "the longevity of the current console cycle" as one of the reasons for its sluggish sales. The updated Wii system, complete with its touchscreen controller serving as a second screen, would seem to be the elixir that the chain is thirsting for.

Smoke and mirrors
Despite all of the November catalysts -- and the economy improving to the point where holiday sales could be promising -- GameStop's guidance for the holiday quarter isn't so hot. The chain's range goes from a gain of 1% to a decline of 7%. The midpoint here is a drop in comps of 3%.

Does that seem right?

Bulls will argue that GameStop is simply being conservative with its guidance, but there's a table sitting a few paragraphs above that begs to differ. GameStop's outlook for its store-level performance has been too aggressive in the past, and the company is hosing down its forecast every three months.

It's not a trick this time. GameStop really is vanishing, one fading quarter at a time.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.