GameStop (GME -2.40%) became one of the market's hottest meme stocks last year amid an unprecedented Reddit-driven short squeeze. Its stock skyrocketed to a split-adjusted all-time high of $86.88 on Jan. 27, 2021 -- which represented a 1,740% gain from the beginning of that month.
But today, GameStop's stock trades at about $25. It lost its luster as rising rates drove investors away from speculative meme stocks, and both the bulls and bears seemed to lose interest in the retailer -- even after it tried to generate fresh buzz with a 4-for-1 stock split and the launch of an NFT (non-fungible token) marketplace in July.
Here are four reasons GameStop lost over 30% of its value this year. Could it ever become a viable long-term investment?
Image source: Getty Images.
1. The shorts aren't interested anymore
GameStop's big short squeeze happened last January because the bears got too greedy and shorted more than 100% of its outstanding shares. Many retail investors noticed that greediness, and teamed up on social networking platforms like Reddit to buy more shares and force those shorts to cover their positions. Larger investors also noticed that trend and bought more shares, which poured even more fuel on the fire.
But as of mid-September, only 16% of GameStop's shares were still being shorted. That's still an elevated short interest ratio compared to the median short interest of less than 2% for the S&P 500, but it's simply not high enough to support another massive short squeeze. So as long as that ratio remains relatively low, the bulls will likely stay away from the stock.
2. Interest rates will continue to rise
Over the past year, rising interest rates have prompted retail investors to rotate toward more conservative investments. The lack of new stimulus checks, which had partly driven that rush toward speculative stocks and cryptocurrencies during the pandemic, has also kept investors away from riskier meme stocks like GameStop. That ongoing trend can also be clearly seen in the ongoing slowdown at Robinhood, which initially benefited from that meme stock mania.
3. GameStop's future still looks murky
The bearish thesis against GameStop is simple: The bears expect its sales of physical games to continue to wither as digital downloads, which bring in much higher-margin revenues for publishers, replace optical disks. They also expect its brick-and-mortar sales of consoles, accessories, and collectibles to dry up as more shoppers buy those products online.
However, the bulls believe GameStop can rightsize its business with aggressive store closures and evolve into an online retailer. Between the end of fiscal 2017 and fiscal 2021, which ended this January, GameStop reduced its store count from 7,276 locations to just 4,573 locations. It also still held $909 million in cash and equivalents at the end of its latest quarter, and it isn't overly leveraged, with a manageable debt-to-equity ratio of 1.1.
It also finally broke a three-year-streak of revenue declines with 18% growth last year, and analysts expect its revenue to rise another 4% to $6.27 billion this year. Unfortunately, most of that growth will likely be driven by margin-crushing markdowns -- which are expected to cause its net loss to widen from $381 million in fiscal 2021 to $425 million in fiscal 2022. All that red ink has made GameStop even less appealing as interest rates continue to rise.
4. The video game industry is still weak
Video game sales soared throughout the pandemic as more people stayed home, but the industry now faces tough year-over-year comparisons as it laps that unexpected growth spurt. Supply chain disruptions are also throttling the supply of new gaming consoles, while inflationary headwinds are curbing the average consumer's appetite for new games.
According to NPD Group, consumer spending on video games in the U.S. soared 29% in 2020 and grew another 8% to $60.8 billion in 2021. But this year, the research firm expects that figure to decline nearly 9% to $55.5 billion as it grapples with supply chain constraints and a drought of big hit games.
About two-thirds of GameStop's stores are located in the United States, and the rest are located in Canada, Australia, and Europe. It doesn't have any exposure to the higher-growth Asian gaming markets, which could have potentially offset the sluggish growth of the U.S. market.
Amid these industrywide challenges, it doesn't make much sense to buy GameStop -- which had already struggled to grow as the broader market was expanding.
But could GameStop be turning into a value play?
Some investors might be wondering if GameStop's stock is fundamentally cheap after its yearlong decline. It might not seem expensive at 1.2 times next year's sales, but investors should recall that the market caps of broken brick-and-mortar retailers can easily fall far below their annual sales.
Therefore, I wouldn't consider GameStop to be cheap until it meaningfully grows its revenues, stabilizes its margins, and narrows its losses. Unfortunately, I don't think any of those things will actually happen, as the evolution of the gaming industry will gradually render its business model obsolete.
