GameStop (GME 1.70%) is best known for its inclusion in the 2021 meme stock frenzy whipped up by Reddit investors. Shares of the once stagnant gaming retailer skyrocketed due to the online community WallStreetBets collectively committing to buy and hold the stock in order to sabotage short sellers' positions.
GameStop's stock represents an underlying business, and that business is deteriorating. Over the years, the company neglected the rapid shift to digital game sales and its brick-and-mortar business suffered. Is it good news that management is finally investing in strategic growth initiatives?
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Changing course
In its fiscal second-quarter earnings release, executives highlighted long-term investments they're planning: Expanding its product catalog, enhancing its fulfillment network and technology, and hiring new talent.
Its surging stock price allowed management to raise enough cash to pay off all its long-term debt and have $1.78 billion in cash left over. GameStop's most recent stock sale completed in June netted the company $1.1 billion for 5 million shares sold. And its debt levels are $424 million lower than the same time last year.
After three years of falling revenue and consistent losses instead of profitability, GameStop has to do a lot of rebuilding. On the surface, the new initiatives align with changing consumer tastes, which has shifted toward e-commerce.
One way GameStop can differentiate itself is to have a robust catalog of titles so gamers can purchase multiple titles with ease, particularly when seeking used games. Instead of waiting for other gamers to list used games on eBay, customers could go to a one-stop shop with confidence.
Investing in the fulfillment network could bring its 'order to delivery' times on par with the market. GameStop leased a 530,000 square foot fulfillment facility in Reno, Nevada. The move will improve its shipping times in the West Coast region. Amazon has conditioned consumers to expect fast and free shipping and customers are quick to change where they shop based on delivery speediness.
Further, GameStop is opening a customer care center and bolstering its Florida staff to improve customer service. That's in addition to hiring folks with experience in e-commerce, supply chain, user interface, user experience, and operations.
While GameStop is investing in these projects, it's also shuttering its lowest-performing stores. In 2018, about 83% of video games were sold in digital form, according to Statista, signaling the lack of demand for stores to carry physical inventory. The trend was exacerbated during the pandemic and in 2020, 91% of game industry revenue was digital. The company's brick-and-mortar locations decreased worldwide by 9% in the last 12 months, which allowed the company to free up its cash flow. Hopefully, rightsizing its footprint could bring the company closer to profitability.
Could this turnaround pay off for investors?
GameStop stock is trading at $205 today, but the company has not generated positive earnings per share (EPS) for three years. In 2018, the last time earnings were positive, the company earned $0.34 per share. This means the stock is trading for 597 times 2018's EPS. The company's best year over the last decade was in 2016 when it earned $3.78 per share. The stock is trading at 54 times its best earnings year in the past decade.
GameStop's exorbitant valuation is the result of the Reddit meme investors' fixation on what has become a battleground stock between retail investors and hedge funds. The WallStreetBets investors don't care about the company's fundamentals but are focused on creating a short-squeeze to deliver their returns. Ultimately, it's an investment fraught with danger for regular investors seeking long-term growth.
If you care anything about valuations, you will stay away from this stock -- at least until this new strategy starts to bear fruit.
