GameStop (NYSE:GME) is still facing threats and GME stock continues to trade at a relatively high valuation. As a result, I recommend investors refrain from taking a bullish position in the name.
The retailer’s refusal to answer questions about its strategy going forward has made me more cautious about its outlook. Nonetheless, I think that GameStop has shown important signs of progress. And, as has been the case for some time, the company appears to have an opportunity to grow rapidly in the medium-to-long-term.
GameStop Is Still Facing Multiple Tough Threats
The video game sector isn’t exactly sizzling anymore. Industry-wide video game revenue climbed just 7% year-over-year (YOY) in August. In the first eight months of 2021, the industry’s sales were up 13% versus the same period in 2020.
The 7% YOY increase in August, which was well below the gains for the beginning of the year, suggests the sector’s growth is slowing.
Also, Take-Two (NASDAQ:TTWO), a top video game maker, announced that its bookings in its fiscal first quarter had tumbled 29% YOY. Moreover, Take-Two still expects to report full-year bookings of $3.2 billion to $3.3 billion, well below analysts’ average outlook of $3.43 billion at the time.
Additionally, as the Covid-19 pandemic eases, demand for video games could slip further as more consumers will be willing to travel and go to out for entertainment.
What’s more, in multiple previous columns, I predicted meme stocks would weaken as the government’s stimulus fades. Although meme names, including GME stock, have held up better than I had anticipated, they’re still showing signs of weakness.
It’s been at least eight weeks since any of that trio — and most other meme stocks — embarked on a huge, short-term rally. Early in the year, gigantic jumps in a day or two used to be “par for the course” for the meme stocks.
As the government’s stimulus fades further into the past, I expect meme stocks like GME to weaken further.
What’s more, only about 10% of GME stock was being sold short recently, down from more than 90% at the beginning of the year and around 30% in February. Given the sharp decline in the number of shares being sold short, it will be very tough for Reddit investors to ignite another short squeeze.
Positive Signs for GME Stock
GameStop continues to take multiple positive steps toward a stronger balance sheet. For example, it’s still increasing the number of consumer-electronics products that it sells, becoming more competitive with companies like Best Buy (NYSE:BBY), Amazon (NASDAQ:AMZN) and Walmart (NYSE:WMT). In the same vein, it’s opening new warehouses that should make its e-commerce operations more efficient.
On top of that, GameStop’s top and bottom lines have shown significant improvements in recent quarters. Last quarter, its net sales jumped 25.6% YOY. In the first half of 2021, revenue climbed to $2.46 billion, up from $1.96 billion during the same period a year earlier.
Additionally, its operating loss last quarter fell to $58 million, well below the $85.6 million it lost on operations during Q2 of 2020.
Finally, GameStop’s gross profit climbed to $320.9 million last quarter, meaningfully above the $252.2 million of gross profit it generated during the same period last year.
GameStop Suffers From a Lack of Transparency
As others have pointed out, the company’s failure to take questions during its Q2 earnings call is worrisome. In the wake of GameStop’s move, Loop Capital managing director Anthony Chukumba told CNBC, “This is a company that is in the midst of this massive turnaround … There’s no color whatsoever in terms of the results, there’s no color whatsoever in terms of what the strategy is going to be going forward.”
Chukumba’s comments were somewhat extreme, but I see where he’s coming from — the call did not include any detailed information about the company’s strategy going forward. That makes it difficult to adequately assess the outlook of GME stock.
Changing hands for nearly three times analysts’ average 2022 revenue estimate, GME stock now has a valuation that’s quite a bit higher than that of similar retailers, like Best Buy.
As I’ve stated in the past, I do believe GameStop’s turnaround could ultimately be successful. Still, given the tough threats it’s facing, along with its lack of profitability and transparency, I believe investors will soon get the chance to buy shares at much lower levels.
On the date of publication, Larry Ramer did not have (either directly or indirectly) positions in any of the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Larry Ramer has conducted research and written articles on U.S. stocks for 13 years. He has been employed by The Fly and Israel’s largest business newspaper, Globes. Larry began writing columns for InvestorPlace in 2015. Among his highly successful, contrarian picks have been GE, solar stocks, and Snap. You can reach him on StockTwits at @larryramer.