GameStop (GME) has struggled mightily over the last year or two, fighting to figure out video game sales in the age of mobile downloads.
About a month ago, things got real ugly for GME stock when video game publisher Electronic Arts (EA) announced it would team up with Microsoft (MSFT) to provide EA titles directly to Xbox One users for a $4.99 monthly subscription — effectively cutting GameStop sales out of the picture.
GME stock took a beating of roughly 6% in a single session.
Fast forward to today, and GameStop stock is rallying once more after reporting strong video game console sales; GME stock is up 7% today alone; quarterly hardware sales doubled year-over-year, and GameStop gave encouraging guidance for the next quarter.
So what’s going on with GameStop earnings, and will this company survive the painful transition into downloadable content intact?
Well … I wouldn’t get your hopes up.
No, GameStop Is NOT Turning Around
It’s important to remember that console sales are volatile: People buy new devices, then play them for many years. Therefore, GameStop showing strong console sales is one of those surprises that is nice … but not sustainable. The Wii package with the highly acclaimed Mario Kart 8 gear has been doing well, and good for GameStop for stocking that.
But look beyond Mario Kart, and the bigger picture for GME stock is much more bleak.
GameStop fell hard in the wake of the Great Recession, with GME stock plummeting from a high of over $60 at the end of 2007 to a low of around $16 in 2012. Sure, in 2013, GameStop stock came back with a vengeance — soaring back up to almost $58 per share when GME was at its peak last November.
Even after today’s rally, GME stands at just $43 — significantly lower than levels from six years ago while the rest of Wall Street continues to set new all-time highs.
I’ll admit that GameStop isn’t going bankrupt. The company is comfortably profitable and can support its good 3.1% dividend yield. GME also took big steps to restructure this year, closing 120 stores in an effort to adapt to the changing video game environment.
However, none of this implies growth.
In fact, GameStop earnings earlier this year already included downward guidance. The fact that this quarter was relatively strong doesn’t change the fact that expectations are pretty darn low for this video game retailer after the past few years of pain.
Beyond the balance sheet, there also are big-picture challenges that are creating quite a headwind for GME stock, including:
- General pressure on all retailers amid sluggish consumer spending.
- Margin issues in retail as prices are kept low to lure customers and fend off online competition from Amazon (AMZN) and others.
- The threat to used video games and reselling, which is a huge part of GameStop’s business.
The bulls will say that GameStop has a forward price-to-earnings ratio of around 10, which is pretty cheap, and the earnings beat that was just reported is a good sign for future EPS growth.
But the EA Access partnership with Xbox One clearly shows a video game business that is rapidly moving away from brick-and-mortar sales games, much in the same way that movies marched steadily away from DVD rental king Blockbuster and onto streaming options like Netflix (NFLX).
The pain will continue for GameStop. While some of the rally of 2013 might have been justified based on unfairly low pricing, the rally has brought GME stock back to par — and the news cycle continues to work against this stock long-term, regardless of this strong console sales report.
I’d sell GameStop stock ASAP if you own it on this short-term bounce. It will continue to circle the drain for some time.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. As of this writing, he did not hold a position in any of the aforementioned securities. Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP.