Please Sell GameStop Before It Round Trips

GameSto GME p’s stock fell exactly $100 on Monday to close at exactly $225 and it was down about $35 in the after-market. While the shares are still up 1,094% from its close as of the end of last year, they are down 53% from its intra-day high on January 28 and down 35% from its closing high on January 27. The stock has had a wild ride the past month but even with Monday’s decline they are still widely overvalued.

GameStop’s stock could go back to its highs and even exceed them. Markets and stocks, at times, have gone higher than what mathematical equations say they should and for longer than investors believe they can. Irrational exuberance can take over but keep in mind that “Bears make money, Bulls make money but Pigs get slaughtered.”

Also remember Warren Buffett’s saying about stocks and the stock market, “In the short run, it’s a voting machine, in the long run, it’s a weighing machine.” Currently, GameStop is the shining bright object that will be dependent on the “Greater Fool Theory” for the stock to remain at such high valuation levels for a long period of time.

Revenue, earnings and cash flow were falling before the coronavirus appeared

GameStop’s fiscal year ends on the first Saturday in February. Looking at the three years of fiscal 2017 to 2019 the company’s revenue fell from $8.6 to $8.3 billion.

It then dropped 22% to $6.4 billion in fiscal 2020, which ended at the beginning of February 2020. This was before the coronavirus had much, if any, impact on the economy and the company. Analysts are expecting a 19% decrease in revenue for fiscal 2021 (which ends this upcoming Saturday) to $5.3 billion.

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During these four years GameStop’s EPS went from a profit of $3.78 to $0.22 last year. Analysts are expecting the company to report a full-year loss of $2.10 per share when it reports in late March or early April.

The cash flow story is worse than the earnings one. In fiscal 2017 GameStop generated $394 million in free cash flow (operating cash flow minus capital expenditures). It was positive the next two years but fell each year to $231 million in fiscal 2019.

Last year it bled $716 million and while it has been a negative $74 million for the first three quarters this fiscal year, it should be positive for the whole year due to the holiday quarter typically generating cash.

Extremely highly valued

Earnings or EPS isn’t helpful as a valuation metric when a company is losing money or has negative cash flows. In this case using market capitalization to revenue is a good alternative. Since GameStop’s revenue has had the extra impact of Covid-19, to give the company the extra benefit of doubt lets use fiscal 2019’s revenue of $8.3 billion, which is even a year before revenue declined 22% to $6.4 billion.

First look at GameStop’s market cap to revenue at the beginning of this year.

  • Stock price: $18.84 (December 31, 2020)
  • Number of shares: 65.2 million (September 2020 quarter)
  • Market Cap: $1.2 billion
  • Using fiscal 2019’s revenue of $8.3 billion:
  • Market cap to revenue: 0.15x

Now let’s look at the market cap to ratio based on Monday’s closing price.

  • Stock price: $225
  • Number of shares: 65.2 million (September 2020 quarter)
  • Market Cap: $4.7 billion
  • Using fiscal 2019’s revenue of $8.3 billion:
  • Market cap to revenue: 1.77x or almost 12 times greater than a month ago

The outlook for the company hasn’t improved that much to justify such a leap in value.

Look at GameStop’s charts from two different perspectives

Most of the time stock charts use logarithmic scales for the Y-axis because the charts X-axis covers years if not decades. Since the multiplication impact of a lot of years would skew how a chart looks this makes sense.

Here is GameStop’s price chart for the past year using a log scale. It shows the shares soaring in value starting in early 2021, but as you can see in the right side Y-axis the price legend is very jumbled. And it doesn’t look too out of place for the price increase when going back a few months since it shows it had been rising from about $5 to $20 before it took off.

The next chart does not use a log scale. The key takeaways are the huge spike up in the stock’s price and the wide range between the lows and highs on any given day recently. And similar to what happened on Monday, the shares could come falling back down very quickly and round trip to the teens or even single digits.

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