GameStop (NYSE:GME) is likely higher than even the upper end of its fair value, at $72.41 as of open on Monday, Feb. 8. This is based on an assessment of its future free cash flow (FCF) and net cash position for GME stock.
That best analysis I have seen so far on GME stock, regardless of how it got here, is from a recent article in Seeking Alpha by a retired sell-side analyst. The article is “Examining the Fundamental Value of GameStop,” by Vinceni Investing, a WordPress blog picked up by Seeking Alpha on Feb. 2.
What makes this article on the valuation of GameStop stand out is how the writer explains both the bear and bull case for GME stock.
Calculating the Value of GameStop Stock
Suffice it to say that he believes that the future value of the forward free cash flow (FCF) of the company is $3.9 billion over the next 10 years. In addition, he believes that the company will have $300 million in net cash for the year ending Jan. 31, 2021.
Altogether then, the total gross value of all its cash flows and net cash is $4.2 billion. However, the company’s FCF must be discounted to the future, based on a discount rate that provides for the risks that could ensue over the next decade.
He does not provide detailed projections for each year. But he says that an 8% discount rate applied to the future FCF yields a present value for GME stock at $60 per share.
However, that is not likely to be a realistic discount rate. There are a lot of risks associated with the future FCF of GameStop. The author believes that a better discount rate commensurate with its risks is 12%. That returns a stock price target of $38 per share.
Therefore, at today’s price of $72.41, GME stock is well above the range of valuation that the former sell-side analyst puts on the GME stock.
He also puts together the bear case for the stock, which of course is zero. This implies that management’s efforts to turn around the company will not work out.
Nevertheless, in any case, there is no upside in any scenario he puts together, at least at today’s price.
What Academics Say About GME Stock
InvestorPlace reached out to a few academics this week about the GameStop stock situation. We asked some about what advice they would give to those who had bought GME stock, among others.
We had an interesting response from Travis Box, Ph.D. (Assistant Professor of Finance, Wilbur O. and Ann Powers College of Business, Clemson University). He said that GME stock would return to its fundamental values:
“At some point, GME and AMC will trade around their fundamental values, that could be tomorrow, or next year, but maybe take some profits if you can.”
He also pointed out that many people had overpaid in buying options that had huge premiums. He gave one example:
“People were paying ~$200 for call options expiring in one week at a $400 strike price where the stock was trading around $400. The stock would have to move up to $600 (in five days) before that payoff was positive. The option bid-ask spreads have also been crazy.”
What to Do With GME Stock
Based on this analysis, if you own GME stock, you are likely to see it return to a fundamental value well below its present price. That implies that investors should take profits if they have any.
If you are in the options market, the implied volatility premiums are excessively high right now for GME stock. So, unless you can sell deeply out-of-the-money covered calls, or sell out-of-the-money puts, you might not want to play in this market.
One thing is for sure. Be careful to gauge whatever you do on your assessment of the fundamentals of GME stock. All indications are now that it is still well above the upper end of its fair value.
On the date of publication, Mark R. Hake does not hold a long or short position in any of the stocks in this article.