Game Trader: Is GameStop's Stock Cheap, or am I an Idiot?

GameStop is one of the more hated companies in retail and the video games industry. They have a reputation of nickel and diming their customers and the company is one of the most shorted stocks in the entire market. Over one third of the shares are being shorted (a way to bet that the company's stock will go down). The stock is down over 77% from its all-time high of $63.77/share that was set in 2007. There is an overwhelming sentiment among the media and investors that GameStop is doomed, but I think much of this is overblown. In this feature, I will take a look at the fundamental reasons why I believe that GameStop's stock (GME) is a buy for value investors. 

Book Value

GameStop's stock is trading below the company's liquidation value. That's right. If they company were to liquidate all of their assets and pay off all of their debts, shareholders would be treated to a sizeable gain. This highlights just how negative sentiment has gotten for GameStop's stock. We are well below the "margin of safety" coined by Benjamin Graham, the Godfather of value investing. GameStop trades at 60% of its book value. This means shareholders could achieve 66% upside from the current share price in the event of a liquidation of the company. This makes no sense and implies that the market believes GameStop will lose money and the current book value will be impaired. While I will readily admit that this is a possibility, the company has remained profitable over the last ten years. 

Revenues

GameStop has achieved over $8 billion in sales for eight straight years. This is rather impressive for a company with a market capitalization below $2 billion. It is rare to see a company trade at such a discount to sales, but the refrain of digital game sales destroying brick and mortar retailers has lead investors to this point. GameStop is priced rather absurdly when compared to its sales. This is largely due to the fact that they are not growing. Markets like to reward companies with revenue growth, and GameStop definitely has a problem on the top line. This has been mitigated in recent quarters, as collectibles is now the fastest growing revenue segment at the company. The headwinds for pre-owned games revenue remains the elephant in the room, but it appears the ThinkGeek acquisition and the efforts to pivot towards collectibles may be able to offset some of that pain in the near-term. New video game hardware and software sales now are a larger component of sales than pre-owned game sales, and this is likely a trend that will continue. With the stock trading a 0.16 price-to-sales ratio, it appears that a lot of this bad news is priced. In my opinion, GameStop's pivot to collectible sales may surprise Wall Street with revenue growth in the coming years.

Earnings 

GameStop is profitable and it trades at an absurdly low 4 times earnings. The benchmark S&P 500 Index currently trades at a 25 P/E ratio and may other retailers are struggling far more mightily to remain profitable. The idea that a company that is still profitable is on the verge of bankruptcy is laughable, but many GameStop bears are ignoring this important fact. For a company to go under, they probably have to start losing money first. This is the key of my investment thesis in GameStop. If the company can stay in the black, or even grow revenues, the book value will stay intact and the P/E multiple may even rise. Companies rarely trade at such depressed valuation, and it is likely due to the fact that they are no longer growing earnings. The lack of earnings growth is mitigated by the handsome 11% dividend yield that the company currently pays out annually.

Dividends

You read that correctly, GameStop pays out a dividend of 11% annually to shareholders. Many bears say that the company will ultimately have to cut or suspend the dividend payments. With a payout ratio less than 50%, GameStop has considerable wiggle room before having to consider such drastic actions. The company paid out its quarterly dividend just a few weeks ago and has provided zero indication of the dividend payments being slashed or suspended. An 11% annual dividend rate is a fine way to be paid to wait for GameStop to get themselves out of this current mess. It is also another reason for large institutions like Blackrock, Vanguard, Fidelity, and State Street to continue to hold onto shares in dividend-focused funds and ETFs.

Debt

The chorus of people calling for GameStop's impending bankruptcy should take a closer look at the company's balance sheet and debt maturities. As of October 2017, GameStop had $817 million in long-term debt on their balance sheet. $350 million of the debt matures October 2019 and $475 million becomes due March 2021. The 2019 Senior Notes carry a 5.5% interest rate payable semi-annually on April 1 and October 1. The 2021 notes carry a 6.75% interest rate payable semi-annually on March 15 and September 15. As of October 2017, the company was carrying $454.7 million in cash on the balance sheet. This is enough to pay off the debt coming due in 2019, barring any kind of catastrophic decline in the company's free cash flow.  It is premature to say that GameStop is on the verge of bankruptcy, but at the same time the company needs to execute in order to keep its head above water for the next few years. October 2019 is a far way out and if management can steady the ship between now and then, shareholders may be treated to material upside.

Conclusion 

Only time will tell if I am an idiot. GameStop provides an interesting setup for contrarian value investors like myself. GameStop releases their latest earnings report today after the market close, and I believe that the bar is incredibly low for the company. They have the tailwind of Nintendo Switch and their own organic growth from the collectibles segment that could surprise investors, but sentiment remains negative and the stock is trading at the lowest share price since 2005. This article was meant to look at the fundamental underpinnings of the company and not the stock chart. A quick glance at GameStop's chart would make even a novice investor go running for the hills, but I believe that there are some very compelling reasons for investors to take a chance on this beaten down and hated company. I will reassess my investment thesis if the company swings to a loss from its history of profitable quarters, but in the meantime I maintain a "buy" rating on GameStop.

Full Disclosure:

At the time of this article, Asif A. Khan, his family members, and his company Virtue LLC had the following positions:

Long GameStop via GME shares and options

Glossary

Market Capitalization - the total dollar value of a company's outstanding shares based on market prices. 

Dividend Yield - the annual dividends paid per share annually divided by the price per share of a given stock.

P/E Ratio - price-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings. The price-earnings ratio is also sometimes known as the price multiple or the earnings multiple. 

The P/E ratio can be calculated as:

Market Value per Share / Earnings per Share

P/S Ratio - price-to-sales ratio is a valuation ratio that compares a company’s stock price to its revenues. The price-to-sales ratio is an indicator of the value placed on each dollar of a company’s sales or revenues. It can be calculated either by dividing the company’s market capitalization by its total sales over a 12-month period.

Abbreviated as the P/S ratio or PSR, the price-to-sales ratio is also known as a “sales multiple” or “revenue multiple.”

Price-to-Book Value - (P/B Ratio) is a ratio used to compare a stock's market value to its book value. It is calculated by dividing the current closing price of the stock by the latest quarter's book value per share.

Also known as the "price-equity ratio".

Calculated as:

P/B Ratio = Market Price per Share / Book Value per Share

where Book Value per Share =  (Total Assets - Total Liabilities) / Number of shares outstanding

Long - to own a stock or have a position betting on it going up.

Short - to borrow a stock and sell it in order to express a negative position in it, essentially a bet that the stock will go down.

Please consult Investopedia for more useful definitions of financial terms.

Investors should do their own research or consult their advisor before acting on this information. This is an educational article and investors should consider each recommendation based on their own risk tolerance and suitability.

Asif Khan

CEO/EIC/EIEIO

Asif Khan is the CEO, EIC, and majority shareholder of Shacknews. He began his career in video game journalism as a freelancer in 2001 for Tendobox.com. Asif is a CPA and was formerly an investment adviser representative. After much success in his own personal investments, he retired from his day job in financial services and is currently focused on new private investments. His favorite PC game of all time is Duke Nukem 3D, and he is an unapologetic fan of most things Nintendo. Asif first frequented the Shack when it was sCary's Shugashack to find all things Quake. When he is not immersed in investments or gaming he is a purveyor of fine electronic music. Asif also has an irrational love of Cleveland sports.