GameStop (NASDAQ:GME) skyrocketed more than 120% last week. In fact, as of March 2, GME stock is up an astounding 161.7% in the last five days at $118.18. But, believe it or not, I don’t think it is not as overvalued as one might assume given the spike.
Granted, the move up was almost certainly due to another mini short-squeeze. When it started moving up, a number of short-sellers, expecting the stock to tank, were forced to cover and had to bid up the stock.
But it also might have been somewhat due to the fact that GME stock was selling below 1 times forward sales. For example, analysts surveyed by Seeking Alpha forecast sales will rise 6.8% in the year to Jan. 2022 to $5.62 billion. But GME stock now has a market value of $7.1 billion.
That puts GameStop on a forward price-to-sales ratio of just 1.26 times. That is not a very high ratio. In fact, if the company is able to pull through the several next years with higher sales leading to profitability, it is highly likely it will sport a higher price-to-sales-multiple.
And just a slight increase in that multiple can mean a large increase in the stock market value. If GME stock were to trade at 2 times next year’s forecast sales (assume a 7.5% sales gain) GME stock would be at $172.61 per share.
Here is how that works out. Assuming sales rise by 7.5% in 2022, they will hit $6,042 million. Now at 2 times sales, GameStop would have a $12.08 billion market capitalization. And since there are about 70 million shares outstanding, the target price per share is $172.61. That represents a potential gain of 46% over the next year or so.
A good deal of this pro-forma valuation depends on the company continuing its turnaround in sales. In addition, once the company reaches profitability, the market will likely be more willing to give it a higher price-to-sales ratio.
What Analysts Think
None of this makes any sense to the establishment analysts. Barron’s reported that “analysts don’t think it will last” when referring to GME stock’s rise last week.
They think it may not be just short-covering. GME stock rose from retail buyers pushing it up. They believe that over time the stock will fall down to $10 or some such lower number.
Most analysts predict negative EBITDA for years to come. Only one analyst, Joseph Feldman of Telsey Advisory Group, has a higher target at $33 per share.
Reuters pointed out that some investors were excited that the existing CFO at GameStop had agreed to leave by the end of March. The idea is that fresh blood at the company might have more modern ideas about how to remake GameStop more of a tech retailer.
What to Do With GME Stock
Now that GME stock has risen so far so fast, the natural reaction might be to wait until it regains some stability, possibly at a lower level. My point, however, is that it is not uncommon for a retail stock to trade for 1.5 to 2 times revenue, especially if earnings begin to appear down the line.
Historically, however, GME stock has traded well below one times sales. Morningstar has an analysis page showing that over the past five years, the average price-to-sales ratio is 0.26 times.
That might be a reason to wait for the stock to drop a bit before taking a long position. Even at three times the average ratio of 0.26 times, at 78 times sales, GME stock will fall to $67.32 per share. That would also give the stock a sort of margin of safety or bargain element from its price today.
On the date of publication, Mark R. Hake did not hold a long or short position in any of the securities in this article.