It has been a tough year for retail stocks. That is, unless we're talking about video game retailer GameStop (NYSE:GME). Shares of GameStop stock have rallied so far this year, with the stock up more than 46% year to date. However, not everyone is optimistic about the stock's future. In fact, GameStop stock is now one of the top 25 most shorted S&P 500 components. Is the bear case accurate or is there more to the GameStop story?
Let the games begin
Short-sellers betting against GameStop stock may be generously rewarded. Fundamental weakness in the company's business model and changes in the broader gaming industry will likely hurt GameStop over the long run. Specifically, the retailer's resale business accounts for about half of its gross profit. This could cripple GameStop in the future as next-generation gaming devices become incompatible with used games.
As fellow Fool Rick Munarriz pointed out last month, new chips used in Sony's upcoming PS4 devices are configured to be incompatible with older games. While new gaming consoles from both Sony and Microsoft (NASDAQ:MSFT) should spur a rise in same-store-sales at GameStop stores, they could also undermine physical game sales.
A rise in mobile devices has resulted in a more digital gaming industry, which means download sales could soon trump those of physical games. In fact, Microsoft's next-generation Xbox will likely require an active Internet connection in order to run, according to gaming industry magazine Edge.
GameStop continues to roll out new initiatives aimed at the digital market, including in-store kiosks featuring downloadable content. Unfortunately, I'm not sure this will be enough to make up for GameStop's eroding resale business. Ultimately, I believe the shorts will prevail and GameStop stock will come crashing back to earth.
Play it safe
Perhaps shares of Microsoft would be a better play for long-term investors. Unlike with GameStop, the video game industry isn't Microsoft's only source of income.