GameStop Has More Hit Points Than the Bears Think (GME)

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GameStop (GME) stock tumbled Friday after it caught a rare “sell” call from a Wall Street analyst, but the selling in GME appears vastly overdone.

gme stock gamestopEveryone knows that GME — a retailer of video games and related gear — is supposed to be the next Blockbuster. After all, the distribution of console and PC games is rapidly moving online.

That’s the old, albeit credible, bear case for GameStop stock. And yet a new research note pointing out that risk — a risk that should already be priced into shares — sparked a selloff of as much as 9% at one point in morning trades.

Analysts at the Benchmark Company cut their rating on GME stock to “sell” from “hold,” MarketWatch reports. The reasoning: The company’s model of physical distribution through retail locations will be disrupted by digital downloads, streaming and subscriptions to content service channels.

From Benchmark’s note to clients:

“We believe the console will complete the turn to digital within the next 5 years, which would effectively dislocate the company’s performance foundation.”

Well, yeah. But how is this news?

There’s a reason why GME stock trades at a forward price-to-earnings multiple of less than 10, despite having a long-term growth forecast of 13%. A stock’s forward P/E is always higher than prospective earnings growth — unless there’s something seriously wrong with sentiment on the name.

GME also trades at a steep discount to the broader market — again, despite having higher growth prospects.

Even more damning, GameStop stock is usually one of the most heavily shorted names in the market. Indeed, fully half of the GameStop stock float is sold short.

Benchmark’s bearish thesis was already reflected in GME’s valuation and sentiment. That’s why the steep decline in shares looks overdone.

Besides, there are reasons to be bullish on GME, too. Bears have been calling for a Blockbuster-like demise for years, and yet GME refuses to cooperate.

GME Dies Hard

It turns out that GME customers are more loyal than anyone was expecting, largely because of the company’s trade-in program. Revenue growth is sluggish, but it’s not in decline. Full-year sales fell only one time in the past 10 years.

Furthermore, GME is using its enormous cash-flow to lavish dividends and share buybacks on investors.

Most importantly, Gamestop is busy diversifying its business model into collectibles and other areas in order to be less reliant on gaming.

The diversification strategy has some Wall Street analysts issuing upbeat forecasts. At the same time Benchmark was cutting its rating, Sterne Agee CRT raised its price target because it believes the GME’s non-gaming businesses could contribute as much as a third of operating profits before the end of the decade.

Lastly, GameStop earnings beat the Street’s profit estimate Thursday, and GME lifted its full-year forecast. True, guidance remains below analysts’ average estimate, according to a survey by Thomson Reuters, but then lowballing the Street is just good thinking.

GME’s failure to die after being priced for death is at least partly responsible for its strong performance this year.

Even after all the market turbulence and Friday’s downgrade to “sell,” GameStop stock is still up 30% for the year-to-date. The broader market, meanwhile, is down about 4% over the same span.

Add it all together, and Friday’s action is unwarranted. Sure, it’s been a crazy week for the market, GME stock has heavy short interest, and any stock that climbs high has more room to fall.

But fundamentally, Nothing has changed with GME in the last 24 hours to warrant such a steep decline.

If you’re bullish on GME stock, stay the course.

As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/08/gamestop-earnings-gme-stock/.

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