Best Buy (NYSE:BBY) and GameStop (NYSE:GME) investors are hoping again. These two embattled retailers have seen their stocks move higher on some recent earnings beats. However, with lingering concerns of their underlying businesses, the hope may be short lived. Do Best Buy and GameStop have sustainable momentum?
Is "not dying" good news?
Over the last few quarters, Best Buy's management has found a way to spin less than stellar results. In the winter quarter, management tried to convince us that slashing prices (and margins) to save market share was a good thing. Due to tremendous competitiveness from both traditional retailers and e-tail giant Amazon.com (NASDAQ:AMZN), Best Buy's management reasoned discounting was a good way to stop the bleeding. The problem with that strategy is that Amazon has always operated on thinner margins than Best Buy; they cannot be beaten at that game.
A margin slashing strategy is a short-term trick because it is unsustainable. Not only does Amazon have less overhead expenses (stores, etc.) than Best Buy, Amazon's investors have proven they are willing to tolerate poor short-term profits for long-term gains.
In addition to the margin concerns, Best Buy's suffering from a product mix problem. In Best Buy's hey day, it was selling flat screen TV's. Unfortunately, after the switch from "boxy" old TV's to flat screens was complete, the sales of these items sank. Best Buy makes much thinner margins on the items it sells today, such as cell phones and consumer electronics.
Back to our timeline, in February, Best Buy's stock surged 7% after reporting fourth quarter earnings that were mediocre at best. In the quarter both revenue and operating income declined, but the stock rallied simply because it turned a profit and cleared (severely) lowered expectations.
Needless to say, I wasn't too surprised when the stock soared again on first quarter earnings (despite mediocre results). For the quarter U.S. comparable sales declined 1.3%, thanks in large part to a 4.1% decline in consumer electronics sales. On the flip-side, appliance sales were up 9%, the gains and declines in these categories tracked industry averages.
In the past few quarters Best Buy has basically rallied on news that they are not dying. At some point, that will not be enough.
Flying into the sun
GameStop's stock rallied 7% following a first-quarter earnings beat. Unlike Best Buy, there are no qualifiers here, the quarter was simply fantastic. Sales rose 7%, same-store sales were up 5.8%, and earnings soared 25% year over year. Even with that fantastic quarter in the rear view, there are still questions regarding the sustainability of GameStop.
The gaming industry is constantly evolving. GameStop's management issued strong guidance, based largely on the current surge of business from the newest generation of Xbox and PlayStation consoles. Considering Xbox's recent flirtations with moving to a more digital format, this guidance seems optimistic. Fans ultimately pushed back at those digital ambitions, but I wouldn't bank on the current "disc" model that GameStop feeds on, long term.
Separately, GameStop is under constant, and increasing, attack from cheaper smart phone and tablet games. Angry birds and flappy bird are just two examples of why a GameStop investment may not fly.
This stock trades at a low valuation, despite a good quarter, because of all the uncertainty just mentioned. While this stock isn't for me, if GameStop's business model can survive these changes, it may look like a bargain one day.
Foolish conclusion: look forward
We must always remember that the stock market looks forward, not backward. It doesn't matter at all what a company has does, only what it is going to do next. That's part of the reason that both of these stocks, despite their recent surge, still trade at decent valuations.
I'm not predicting either company will go out of business. However, they're risky stocks. They will survive, but their futures are too uncertain to overcome limited upside.
Adem Tahiri has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com and GameStop. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.