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Avoid The Battle Over Gamestop Stock

Over the last couple months, I’ve shown you stocks to avoid…

Stocks to consider buying…

And some of the best stocks related to the coming Internet of Things…  Which you can find linked further below.

All these recommendations are to help you either avoid pain and terrible stocks.  Or to help you find potentially great stocks to invest in during this pandemic.

If you do both well, it helps you earn higher than average investment returns and build wealth.

Because the fewer investment losses you have the more capital you keep. And the more capital you keep the faster you compound your money.

Today I want to tell you why to avoid buying Gamestop – because this battle and the meteoric rise of its stock is going to end badly.

Gamestop (GME) is a used video game retailer that had massive success in the past… But is now in the middle of a transition of its entire business model to keep up with the gaming industry going more digital and away from hard copies.

And there’s a battle going on right now with its stock.

On one side you have hedge fund billionaires shorting the stock.

And on the other you have day traders who are trying to break the short sellers.

So far, the traders are winning.

In the last few days alone, trading in Gamestop stock has been halted 9 times as of this writing due to the battle.

What’s going on?

The full details will come out in the coming days, weeks, and months… But as of now, a group of Reddit members via the Wall Street Bets group on the site is buying as many shares of GameStop as they can to drive up the price of its shares.

This is crushing the Wall Street hedge funds and causing them to lose billions of dollars.

Why are the day traders doing this?

As of this writing, its not really clear for most, but many are doing it because they like Gamestop and want to make money of course.

Some on the group are claiming they were able to turn $50,000 into $22 million in only a few weeks by buying up Gamestop shares as they skyrocketed.

I’m not going to get into the argument about which side is right or wrong here… Because frankly it doesn’t matter.

What I do want to do though is tell you why you should avoid this battle at all costs and not get sucked into the mania surrounding Gamestop.

To tell you that though, I need to go back in time and tell you why short sellers began betting against the stock.

Gamestop Is Dying

For years as the gaming industry grew into the behemoth and worldwide leading entertainment industry it is today, Gamestop was one of the leading benefactors.

It grew from a small company into a large one as video gaming turned from a “nerd” only hobby in the 1980’s into the $160 billion annual sales industry it is now.

And this number is projected to grow to $200 billion by 2023.

Gaming is now so big that its not only the largest individual entertainment industry in the world.  It also now dwarfs the combined $62.7 billion in annual revenue the movie music industry produces.

And Gamestop rode this wave for years by allowing gamers to trade in old games they no longer wanted to play for in store credit… Credit that gamers could then use to buy new games at Gamestop.

The business model was fantastic for Gamestop because the margins were large.

Often gamers would trade a lightly used and relatively new game that they’d bought a month ago for $60 into $25 in store credit to buy another game.

Gamestop would then resell that used game for say $50 and pocket the spread… But not only this, it would essentially be able to do this multiple times for the same game… And then spread that out to thousands of games and gamers.

Why?

Because after you beat a video game, you often want to sell it and buy a new one instead of replaying it.

Again, this propelled Gamestop into a giant in the gaming world and allowed it to buy up competitors and dominate the gaming resell market.

But in recent years that changed as gaming went more digital and away from physical disc copies.

This destroyed GameStop’s business model because you can’t trade in digital copies of games like you can with a disc.

This transformation in recent years caused Gamestop stock to begin falling dramatically.

From $9.5 billion in 2011 to only $5.2 billion in the last 12 months up to today in 2021.

This is a fall of 45.3% in that time.

And the falling sales and rapidly changing business model also led Gamestop from creating large profits and cash flows into unprofitability.

In 2011 Gamestop produced $663 million in operating profits, $408 million in net profits, and $394 million in free cash flow.

Those same numbers now are negative $198 million in operating profit, negative $275 million in net profit, and $150 million in free cash flow.

But the only reason free cash flow is positive is because the company issued $197 million in debt.

Without this and the once great company is now unprofitable on all metrics.

If you follow our other articles you know this is already bad… I look for operating profit margins above 10% on a consistent basis and for FCF/Sales margins to be above 5% on a consistent basis to consider recommending them to you.

The transformation of its business model is a bigger problem by far though… Because unless it can successfully pull off its new plans to become “the social/cultural hub for gaming,” and to “build a frictionless digital ecosystem for gaming” its revenues, profits, and cash flows will continue to crater. 

And most businesses don’t make these kinds of gigantic transformations in their businesses when new technology disrupts them.

Think Blockbuster video getting crushed and disappearing when Netflix came along as only one example.

The even bigger problem with all this?

Its going to end horrifically for those joining in the buying of Gamestop late.

Why?

When the traders move onto their next target, which is already happening to a degree with AMC Theaters, Naked Brands, Macy’s and other – Gamestop shares will crater.

This will hurt not only the hedge funds which is the stated goal of many of the traders… But it will also hurt the people who came in and bought Gamestop late.

Again, why?

Let’s say you saw the craziness surrounding Gamestop and put $10,000 into Gamestop and bought 33 shares for $300.  In a matter of hours, you saw this go up to $345 per share and you turned $10,000 into $11,385.

This is a great return of 13.9% in let’s say a day… 

Again amazing.

What happens now though?

If you kept holding and you expected it to continue going up you’ve now been crushed and lost 61.74% of your total money – again in only 1 day.

Your original $10,000, that you turned into $11,385 in one day is now worth only $4,356 – in less than 24 hours… Because as of this writing the market is still open for another 5 hours.

This is why you need to avoid this battle.

There will still likely be ups and downs in the stock as both party’s fight.

But if you don’t know when to get out – and no one does for sure – you’ll get crushed.

Another way to illustrate this craziness…

This is GameStop’s stock chart from the last six months.

Stocks don’t spike straight up like that in such a short time unless there’s an extreme amount of speculation going on.

In the last six months alone Gamestop stock is up 8,567% on almost zero positive news…  And as it reports an 45.3% fall in its revenue since 2011… Causing its operating profits, net profits, and free cash flows to fall into unprofitability.

A final illustration of how crazy things have gotten for Gamestop…

Its P/E is now 404.

Its P/CF is 113.5.

And its forward P/E is unreadable due to expected future unprofitability.

On all three metrics, I look to buy investments below 20 to consider them undervalued.

These show that Gamestop is massively overvalued right now.

And this means owning its stock gives you no margin of safety in investing terminology.

When you invest in stocks that have a margin of safety it makes the investment safer.  And it also means you should expect to earn higher returns owning it in the coming years.

The inverse of this is also true…

When you invest in a stock without a margin of safety it makes the investment riskier.  And it also means you should expect to earn less owning it going forward.

Because of the massive speculation going on in its stock right now and everything else I wrote about above… Avoid Gamestop stock at all costs unless you buy it as a pure speculation and are prepared to lose 100% of your money.

This isn’t investing… This is 100% gambling.

Conclusion

If you’re looking for a solid, safe, dividend paying, stable, and enormously profitable investment to buy… Avoid the craziness surrounding Gamestop stock.

Use the following links to some of our recent articles to learn other ways to protect yourself and your investments in these uncertain times.

Disclosure – Jason Rivera is a 13+ year veteran value investor who now spends much of his time helping other investors earn higher than average investment returns safely. He does not have any holdings in any securities mentioned above and the article expresses his own opinions. He has no business relationship with any company mentioned above

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