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

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 Amazon.com, 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%.

Since the dividend accounts for less than half of the company’s profits, and it has minimal net debt, that leaves the company with even more money. They’ve used some to make acquisitions. However, the lion’s share of the remaining cash flows go into a robust share buyback. In 2010, GME stock had 168 million shares outstanding. Since then, they’ve bought back between 5% and 10% of the outstanding stock every year, cutting the share count to just 107 million shares today.

Tech Brands Growth: GameStop stock isn’t just video games. The company also sells collectibles in stores, a nicely growing business, though perhaps a faddish one. It has an online business, though it’s not especially powerful. As a middleman, it’s also subject to the risk that Microsoft and other such suppliers provide games directly to consumers digitally.

However, one of the other businesses is genuinely exciting. GameStop’s Tech Brands division offers real value for the company. Tech brands consist of smaller non-video game based stores. One example is operating Apple Inc. (NASDAQ:AAPL) Apple stores in smaller markets. GameStop is also the largest operator of AT&T Inc. (NYSE:T) authorized reseller stores.

Tech brands earned $29 million in net income in 2015. This figure soared to $90 million last year. Management has guided $120 million in profits this year, jumping to $200 million in 2019. GameStop’s current enterprise value is $2.3 billion. Assume 10x earnings on that $200 million in profits from tech brands, and the rest of the business needs to be worth just $300 million in 2019 to support today’s stock price. And that’s before accounting for the fact that there will be far fewer shares of GME stock left outstanding by then.

Verdict on GameSpot Stock

I think the bears are overplaying their hand on GME stock. Sure, the digital trend is a problem. The video game business will eventually be gone, be it five or ten years from now. However, the company is trading at under 7x earnings, and it has three other viable business lines including one with real upside potential. The company is paying a massive dividend and also soaking up the supply of outstanding GameSpot stock.

This is a classic Buffett last-puff-of-the-cigar-butt stock. Sure, GME will struggle to even hold earnings in place, let alone grow. But if a business trading at 6x earnings survives for 15 years while returning all profits to shareholders, things still turn out well. From today’s price, you can score a win with GameSpot stock.

At the time of this writing, Ian Bezek owned GME stock and GILD stock. You can reach him on Twitter at @irbezek.


Article printed from InvestorPlace Media, https://investorplace.com/2017/04/gamestop-corp-gme-stock-3-pros-3-cons/.

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