In all my articles about stocks on InvestorPlace, I save my investment thesis for the end. But for GameStop (NYSE:GME), let me be upfront: I do not like the stock, its fundamentals or certainly its lofty price.
There are many good stocks listed on the U.S. stock exchanges, and many of them still are undervalued while the U.S. stock market is near its historic highs. So why even consider GME stock? Some would say speculation, but that’s not a good reason to buy the stock.
GME Stock Fundamentals Refresher
Back in April, I wrote an article about GME stock in which I reiterated several key financial metrics that left me unenthusiastic about the stock. Some of them were:
- Declining sales growth
- Negative net income
- Collapse of total shareholders’ equity
- A non-working business plan
- Weak free cash flow growth
- Nonexistent long-term growth
On the day of that article’s publication, the opening stock price was $185.88. Today the stock opened at $187.79 per share. GME stock rallied to a high price of $344.66 on June 8, 2021, and then it collapsed about 50%. I am not surprised at all by the selloff, but I am astonished by the rally. There was no justification for it.
Stock Dilution: Another Fool’s Game Theory
The stock fell in early June 2021 as news about a share dilution plan was announced. “Fear of earnings dilution because of the company’s plans to issue 5 million shares from ‘time to time’ added to the negative sentiment.”
This stock dilution is a negative valuation factor and apparently, investors understood this and acted accordingly. Meanwhile, GameStop has appointed a new CEO and a CFO. I usually don’t have any problem with changes in management, but multiple simultaneous changes is worrying.
GameStop’s problem isn’t just its very poor fundamentals; it’s much deeper than that. Meme stocks will inevitably someday stop having massive gains based purely on speculation.
When logic returns to the market, GameStop will have to deliver results. It will need growth, profitability, institutional support and positive earnings per share surprises. Many investors have already started to evaluate the reality of GME stock. They won’t want to get trapped in another greater fool’s theory stock rally and keep buying the stock with the unrealistic expectation that the stock may go “to the moon.”
This is a very naïve investment philosophy. It lacks positive results and is too high-risk. It’s not a sound investment approach.
Q1 GME Stock Results
GameStop’s Q1 results weren’t all bad news, but there was a lot of it.
First, the positives: “net sales increased 25.1% to $1.277 billion, compared to $1.021 billion in the fiscal 2020 first quarter.”
On the other hand, the company had an “operating loss of ($40.8) million compared to ($108.0) million in the fiscal 2020 first quarter” and “net loss of ($66.8) million, or ($1.01) per diluted share as compared to a net loss of ($165.7) million, or ($2.57) per diluted share, in the fiscal 2020 first quarter.”
The company has raised “$551.7 million in net proceeds through the issuance of 3.5 million shares of common stock under its ‘at-the-market’ equity offering program, resulting in total shares outstanding of approximately 71.9 million.” and has “$770.8 million in cash and restricted cash, compared to $583.9 million in cash and restricted cash in the prior year.” I want to see how this cash will be used.
Cash itself is valuable, but it does not make any stock more valuable. Free cash flows are far more relevant to the valuation of a stock.
What About the Business Plan?
Competition in the gaming industry will only get more intense. As I stated in my previous article about GME stock, the company’s business plan isn’t working at all. That’s a serious problem.
I don’t know yet what GameStop will do with all the cash it has on its balance sheet. But its stock is too risky and lacks strong fundamentals, making it overpriced. Even at a reduced price from its highs, it’s not a bargain. Stock dilution will only make things worse.
I would completely avoid GME stock.
On the date of publication, Stavros Georgiadis, CFA did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.