The question of whether GameStop (NYSE:GME) is a buy really boils down two things: are we trading or are we investing? GME stock is not an investment. It’s too volatile and the valuation doesn’t make any sense.
As a trade though, there could be merit.
GameStop just reported its Q4 earnings and the report was okay. It wasn’t out-of-this-world great, but there were bright spots in it too. It’s one of those tricky stocks that falls into the speculative holdings group and investors have to know what they’re getting into.
First, the earnings.
The Main Point to Focus On
The company reported its fourth-quarter results on Mar. 23, missing on earnings and revenue expectations. The latter declined roughly 3.3% year over year. Not great, but the world’s not ending here (which is important for later).
On the plus side, same-store sales were positive and e-commerce revenue soared 175% year over year. Now that is great news.
However, the most important part of the quarter isn’t a business metric. Instead, it’s the fact that GameStop said it will consider raising capital at some point this year. When it comes to the stock price, that may be the most impactful thing from this entire quarter.
Interestingly, management didn’t mention the capital raise on the conference call. But considering the stock has exploded in value vs. where it was trading a few months ago and it seems crazy that the company wouldn’t raise capital. Others, like AMC Entertainment (NYSE:AMC) have used the Reddit short squeeze as an opportunity to raise capital. Will GameStop?
Why Raising Capital Matters
Raising capital via a stock sale matters for one reason: Supply.
The whole reason anyone is even talking about GME stock at all is because of the epic short squeeze we’ve seen. Basically, short-sellers have been betting on GameStop’s demise.
At one point, more than 100% of the float was sold short. To be honest, that doesn’t even make sense — particularly from a risk/reward perspective. The only thing that makes sense is that short-sellers were planning on bankruptcy and not worried about having to buy the stock back.
Now remember when I said the world wasn’t ending and that was important for later? Right, well that’s now. While GameStop’s clearly not thriving, it’s not going out of business either. That’s kickstarted a huge short squeeze in the stock, with buyers putting the heat on shorts by driving the price up.
Essentially, the shorts have to get out of the stock by buying shares. However, that in turn can drive the price up too. However, if GameStop steps in and sells into the market, the increase in supply may be enough to let some of those trapped shorts get out.
Who knows. There are a lot of ways to raise capital, but a stock sale would make the most sense given the run in the share price.
Why GME Stock a Buy or a Sell
The bottom line for GME stock is simple: It’s too volatile for most investors. This isn’t an argument about valuation or e-commerce trends. It’s a simple argument of market mechanics and finding a balance between its fair price and its float.
In the first trading day after reporting earnings, GME stock fell 33.8%.. In the next session, it rallied 52.7%.
These moves might be okay for traders and if they have found themselves on the right side of it, they have probably cashed in more than once by now. However, for an investor these moves are simply too big.
Further, if investors can live with the volatility, they probably can’t live with the valuation. GameStop trades at 2.5 times sales and analysts are very optimistic on growth. They expect 6.7% sales growth this year and a 1.1% decline next year. On the earnings front, the situation is forecast to improve, but analysts don’t expect it be profitable this year or next year.
Raising capital is actually great from an investment perspective, because it will help fund GameStop’s transformation and make it a better company. But at current prices, how much reward is really left?
For now (and likely for a long time) GME stock is a trader’s paradise — not an investor’s paradise. Interestingly, the flip side of “not being a buy” is usually that the stock has a solid short case. But with the market mechanics the way they are currently (i.e. the short interest), GameStop isn’t a short, either.
For most investors, it’s best to observe this stock and nothing more.
On the date of publication, Bret Kenwell did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell.