GameStop (NYSE:GME) has not yet released its sales and earnings for its fiscal Q1 ending April 2021. Expect the company to release reasonably good numbers, based on its pre-release of its 9-week numbers on April 5. However, I believe that GME stock is going to find life very difficult as it moves forward.
For one, it is going to be a long time before the company can complete its transformation into an e-commerce company. That is going to make GME stock quite volatile. It might not be successful, as well, for some very good reasons.
Let’s take a deeper look into those issues.
GameStop’s Growth Issues
GameStop eliminated all its long-term debt, as of May 3, after its recent $551 million equity capital raise. But, it is trying to become a more hardware-centric company — selling consoles, TVs, PCs, etc.
The problem is its software sales had much higher margins. Its overall margins are going to fall at the same time that sales will drop from selling less gaming software. That is not a good combination.
Moreover, GameStop will essentially be competing against much more experienced high-tech hardware selling companies. This includes Best Buy (NYSE:BBY), Amazon (NASDAQ:AMZN), Walmart (NYSE:WMT), Target (NYSE:TGT) and even Apple (NASDAQ:AAPL).
A recent Seeking Alpha article points out that GameStop’s margins are set to fall dramatically as a result of its move to e-commerce. The author believes that the forces aligned against the company will cause it to fail.
It is interesting to note that the company’s 9-week update did not talk about its margins, only its sales growth. As the Seeking Alpha article points out, the company admitted in its Q4 conference call that its software sales had 27% average gross margins. But its hardware sales were significantly lower than this, such that its overall margin rate was only 21%.
On top of these issues, GameStop needs to reduce the number of physical stores it has outstanding. As I pointed out in my last article on GME stock on April 20, the company had 4,816 stores at the end of 2020. GameStop is trying to “de-densify” these store counts.
This will be expensive, both in terms of lease costs, personnel costs and lower sales. In addition, GameStop closed 693 stores or about 12.6% of its base at the time. At that rate, it will take over five more years to get down to 20% of the Q4 number.
Where This Leaves GME Stock
In my last article, I argued that GME stock is not worth more than $82.19. I also wrote that most people would want to wait until it is at a bargain price or one-third below that at $54.79. At today’s price of $193, GME stock could still drop 57% to reach $82.19.
So far analysts agree with me about GME stock being overvalued. For example, TipRianks.com reports that 6 analysts who’ve written on GME stock in the last 3 months have an average 12-month price target of $55.80. That represents a potential decline of 71% from today’s price.
The same is true at Seeking Alpha. Their survey shows that the average target price is $22.80, or a 88% decline. Marketbeat.com is even lower at $13.36. That represents a potential 93% drop. The average of these three analyst survey sites is a decline of 84%.
So analysts are about as far apart from today’s stock price today as you can get. Something has to give here. Either the market is right and GameStop is going to be able to transition to a non-physical store, profitable online sales company, or it won’t.
Here is where we can use a bit of probability analysis to aid us. Let’s say that there is a 40% chance that analysts will be right and GME stock will drop 83%. Next, let’s estimate that there is a 30% chance it could rise another 30%. Lastly, let’s say there is a 30% chance it could rise say 15%.
This results in a weighted average expected return of -20%. Here is why. The first scenario results in an expected return (ER) of negative 33.2% (i.e., 40% x -83% = -33.2%). The second scenario has an ER of 9% (i.e., 30% x +30% = 9%). The third scenario yield 4.5% (i.e., 30% x 15% = 4.5%). Therefore, if we add all three scenarios together, -33.2% + 9% + 4.5%, the result is negative 20%.
This means that at best, expect to see GME stock fall to $144.55, if not further. This is not a good investment prospect for most investors.
On the date of publication, Mark R. Hake did not hold a long or short position in any of the securities in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.