Putting it simply, for months GameStop (NYSE:GME) stock has been waiting for the other shoe to drop.
Chatter about it on Reddit’s r/WallStreetBets subreddit is nowhere near where it was at the height of meme stock madness. Yet shares in the video game retailer turned king of meme stocks have managed to remain at inflated prices.
Yes, ever since Chewy (NYSE:CHWY) co-founder Ryan Cohen took over its board, the company’s underlying value has gone up, thanks to the potential for his digital transformation plans to pay off. That amount is well above its pre-meme prices. Back when GME was just a “cigar butt” stock favored by value investors like Michael Burry of Big Short fame, GameStop stock was less than $10.
But that’s far from saying GameStop won’t tumble once valuation concerns become top of mind again. Even if its digitalization plans pan out, the company’s maximum value is likely between $72 and $119 per share. In other words, 26% to 55% below where the stock trades as of this writing.
Now that’s not to say the stock is set to experience some sort of free fall that sends immediately back down to much lower prices. Chances are, further declines will likely be gradual. Nevertheless, given the inevitability of GME stock falling down to more reasonable price levels, there’s no reason to dive in at today’s prices.
GME Stock Has Room to Fall
GameStop may be making the right moves to make its online retail turnaround work. The billions it’s raised via at-the-market equity offerings provide it with the cash it needs to cobble together the fulfillment infrastructure needed to take on e-commerce heavyweights like Amazon (NASDAQ:AMZN).
The company has also put together a more tech-savvy C-suite team that includes talent with past experience at the dominant online retailer itself.
There’s no doubt GameStop has the cash and has brought on the talent to turn its ambitions into tangible results. But this may not translate in GME stock holding steady, much less make it head higher from today’s levels (around $160 per share).
Why? Today’s valuation more than reflects this company’s long-term potential value as an e-commerce pure play.
If it all works out, at best GameStop’s true value will fall between $50 and $100 per share, based on numbers the InvestorPlace Research Staff ran back in May. Taking its online sales from the past year ($1.5 billion), and assigning it a multiple in line with other growing e-commerce companies, an enterprise value of $3.5 billion to $7 billion appeared to be a fair valuation.
From there, add its net cash position. As our Mark Hake calculated in July, following the secondary offering GameStop had about $1.9 billion in cash. Subtract its short-term debt of $48.1 million, and with no outstanding long-term debt, we get $1.85 billion in net cash. Add this to its EV, and you get a valuation range of $5.35 billion to $8.85 billion. Divided by its share count (74.22 million), and its fair value comes in between $72 and $119.20 per share.
It’ll Take Time, But it’s Bound to Happen
Admittedly, the fall of GME stock towards its fair value will likely not happen in the blink of an eye. Instead, further pullback will likely be more gradual than the 45% dive seen since the peak of June’s second meme stock wave.
Even so, what difference does it make whether a stock you own is going to immediately collapse, or head lower at a slower pace? Granted, you may be still holding GameStop in the hopes it can make one last pop before the party’s officially over. Short interest in the stock has also remained steady. To some, this may suggest there’s room for yet another short squeeze.
Yet as I’ve discussed while talking about other short-squeeze plays like Clover Health (NASDAQ:CLOV), a crowded short side is just one part of the equation. To move higher, the retail trader army needs to pile in on the long side as a group. It may be tough for this to happen, given few new participants are hopping onto the meme stock bandwagon.
In short, GME stock may have a chance to pop again before it fully drops. But buying on this chance, in exchange for risk that it will fall once 2021’s top investing trend ends? This appears to be a wager not worth making.
Stay Away from GameStop
The issue with GameStop shares isn’t one of hype versus substance. It’s one of trading price versus fair value. Cohen’s turnaround could pan out. Yet even if this plan works out, shares at best will be worth 26% what they trade for today.
Another pop may be a possibility. But with a continued drift to lower prices an inevitability, it’s best to stay away from GME stock.
On the date of publication, Thomas Niel 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.
Thomas Niel, contributor for InvestorPlace.com, has been writing single-stock analysis for web-based publications since 2016.