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Should You Buy GameStop Corp. (GME) Stock? 3 Pros, 3 Cons

GameStop is down for the count, but it's not "Game Over" for longs by any means

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GameStop Corp. (NYSE:GME) is a classic battleground stock. And it has been one for the better part of a decade. As early as 2011, bears flooded into GME stock, hoping that, Inc. (NASDAQ:AMZN) would put the company out of business. Those plans backfired in 2013, when a new gaming console cycle sent GME stock up from $17 to $55.

Should You Buy GameStop Corp. (GME) Stock? 3 Pros, 3 Cons
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However, that momentum is long gone, and GameStop is again putting up weak results. Its video game business struggling. Bears argue that this time, the company is really going down the RadioShack road to ruin.

Pessimists have certainly done a number on GME stock, it trades at 6.6% dividend yield nowadays as the price continues to fall. But don’t count out the bull case entirely. GameStop might be able to revive itself one more time.

GME Stock Cons

Microsoft ThreatMicrosoft Corporation (NASDAQ:MSFT) recently announced the new Xbox Game Pass. This pass will be an unlimited access service to more than 100 generally older but popular Xbox titles. Unlike the unlimited streaming music services, this offering won’t destroy the market for games, since games won’t hit the service for many quarters after release.

Still, it highlights the real risk that GameStop, as a middle-man, gets removed from the video game value chain. If Microsoft and other console producers sell or stream to consumers directly, it leaves little for GameStop to do. Due to slow internet speeds, data caps, hard drive space limitations and portability, among other reasons, the physical market isn’t about to vanish. This isn’t PC games we are talking about; analysts project physical will be a major part of the console market for another five to ten years. But Microsoft’s move is a reminder of what will eventually happen to the market.

Current Profitability May Not Last: GME stock looks cheap. Really cheap. However, that profitability is tied to physical video games and the resale market for said games. I think this market will remain robust for at least a few more years. But if consumer adoption of digital console games happens more quickly than expected, GameStop stock would get hit.

One parallel to look at is Gilead Sciences, Inc. (NASDAQ:GILD). That company has consistently traded at a sub-10 price-to-earnings ratio for several years now. But as earnings keep dropping, the price can continue to fall, while the P/E ratio stays at the same level. GameStop’s earnings have continued to rise in recent years, and their revenue cliff appears to be much more gradual than Gilead’s. But that sort of scenario — perpetually low P/E ratio as earnings decline — can’t be ruled out.

Weak Guidance: Investors hammered GME stock last month on earnings. It tested multi-year lows following the downbeat report. GameStop blames the video game hardware cycle for the current problems. They argue that things will pick back up this fall as the new consoles come out and players rush to buy games for the new systems. The recent launch of the Nintendo Switch has already helped. GME has done robust business in this console, and has had trouble keeping the Switch in stock. The bulls would point to 2012 and 2013 for reference. The last console upgrade cycle resulted in GameStop stock tripling.

However, bears argue that it isn’t the console cycle at fault. Instead, they suggest that the migration to digital is permanently reducing GME’s reach. The company projected flat revenues for the year and a modest decline in earnings. The market, however, had expected revenue growth and EPS to hold level. Early 2017 is likely to remain weak. The holiday quarter should be the one that determines if GameStop management or the stock’s skeptics are ultimately right about the cycle.

GME Stock Pros

Massively Profitable: GameStop is one of America’s cheapest sizable businesses. It trades at 6.7x earnings, and a similarly eye-catching free cash flow ratio.

Sure, about 70% of GME’s business is selling new and used video games. This market is going away, albeit much more slowly than bears had expected. However, the company is showing growth in its other three segments, including online, collectibles and tech brands. While GameStop’s overall revenues have been generally flat over the last five years, generally showing low single-digit annual growth, due to the share buyback, the company has shown steadily rising earnings. They’re up from $2.41 in 2012 to $3.78 last year despite the sluggishness in the physical video game market.

Share Buyback/Shareholder Return: Given GME’s huge profits, on both an accounting and free cash flow basis, it has plenty of money to reward shareholders. And management has delivered. GameStop stock raises its dividend every year, and now yields 6.6%. That may sound way too high, but it’s fully supportable given the 6.7x P/E ratio. In fact, the dividend payout ratio is under 50%.

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