Any Way You Look At It, GameStop Stock Is Still Wildly Overvalued

GameStop (NYSE:GME) cleaned house. Virtually the entire board of directors will be gone soon, it's searching for a new CEO, and the activist investor who called most loudly for a change in direction for the video game retailer is now chairman of the board.

It also has a groundswell of investor support behind it. It has a fistful of cash (or soon will) from raising money from an equity offering because its stock is trading some 700% higher than where it started the year, and it's about to pay off all of its long-term debt.

With a video game console upgrade cycle under way and its stores reporting rising same-store sales while online sales soar, GameStop looks better positioned for a new wave of growth than it has in years. Is there any reason why its stock should not be a buy?

Father and son playing video games

Image source: Getty Images.

The future of gaming

There's little doubt GameStop is better off financially than it was not too long ago, and it's with good reason many were waiting for the upgrade cycle to finally kick in. The sale of hardware, software, and accessories was always expected to line the retailer's pockets.

Yet it was also clear GameStop needed to look beyond the transition to the latest generation of gear and games. The interval between upgrades has extended to over seven years, and it was unlikely the video game retailer could limp into the next cycle, let alone survive. Something needed to change.

That is what new chairman Ryan Cohen was arguing when he said GameStop needed to deemphasize its physical retail footprint in favor of an enhanced digital presence and become the "Amazon of gaming."

This is not necessarily done by selling all manner of goods, but by catering to today's gamer who is increasingly accessing games digitally, either playing online or downloading games. Out of necessity, GameStop learned to embrace e-commerce during the pandemic.

Digital sales surged 175% in its fourth quarter while comparable store sales rose 6.5%, even though net sales fell 3% as it closed underperforming locations (or, more likely, because it did so).

Clearing the decks

Now there is really nothing that stands between Cohen and his vision of a differentiated GameStop. Executives remaining in leadership positions are either other activist investors or people Cohen brought on board. 

The new directors who will be elected at the annual shareholder meeting will be those who will support Cohen's plan for taking the retailer into the future. That it will also have the financial wherewithal to effect the changes sought doesn't hurt.

Earlier this month, GameStop increased the size of an at-the-market share offering to 3.5 million shares, which -- depending upon when it sells the stock -- could net it around a half billion dollars. And it's using the cash it has on hand to retire early some $216 million in long-term debt early, eliminating any potential drag from having to service that debt.

A good price

So GameStop has cleared the field in front of it, and assuming you buy into Cohen's vision of the company as a consumer-driven, primarily online-focused retailer, there's plenty of runway ahead for it and its stock to take off.

Yeah, about that stock. While its current valuation has given it the financial freedom to pursue Cohen's dream, investors need to consider the kinds of returns they can expect if they buy in now -- and with the stock trading over 2,600% above where it was a year ago, it could seem a bit overvalued.

But is it? It could just be that GameStop was wildly undervalued last year as the market assumed there was little relevance left to the video game retailer. 

Because GameStop has been generating losses, you can't measure it on a price-to-earnings scale, but at a little over two times its sales, the retailer's valuation may be elevated, though not ridiculously so. 

It's a little different if you look at its free cash flow, as it trades at 187 times the cash profits it produces, but it had been using cash previously and is only over the trailing 12 months not doing so, so the figure will be skewed.

Risky business

GameStop's stock is not discounted by any stretch, but it's also not necessarily the nosebleed level it initially appears. A lot of the optimism for the future has already been baked into its share price, and because the success of Cohen's vision is so uncertain, it's hard to recommend buying the stock.

Still, although it may feel like buying at the top, putting a small bet on GameStop coming through this wild ride not only intact, but better prepared for the future of the video game industry, might not be such a terrible idea.

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