Video game and electronics retailer GameStop, Inc. (NYSE: GME) used to be the go-to location for purchasing the latest trends within the gaming sphere. But after failing to capitalize on the rapid shift toward digital and PC gaming, the company finds itself in almost constant bankruptcy talks. The retail sector as a whole has been under immense pressure from investors and analysts who are under the impression that every retail firm will close its doors due to a macro shift in favor of e-commerce shopping. As a whole, I find this theory to be unwarranted. In fact, I see the massive depreciation in retail equity prices as a terrific buying opportunity for value investors who are willing to stomach short term pain for long term gain.
Since reaching an all-time high of 63.30 dollars on December 24, 2007, GME has fallen roughly 91 percent to the closing price of 5.55 dollars on October 4. Weak internal logistics and lackluster capital management have made the stock one of the most widely shorted equities on the market. In layman’s terms, shorting a stock is equivalent to betting that its price will decrease in the future. Shares of GME have been heavily shorted for quite some time now. While the company does have many improvements to make, current investor sentiment remains far too pessimistic. A whopping 70 percent of GameStop’s float (the number of shares available to the public for trading) are being sold short. To put this into perspective, a value of short interest relative to float above 20 percent is considered extremely high.
More importantly, GME controls a favorable cash position relative to its market capitalization. As of October 4, 2019, GameStop’s market capitalization registered at 490 million dollars. And for its most recent fiscal quarter, the company had 424 million dollars of cash on hand. This small range indicates the company has been oversold to an extreme. Market capitalization of any company is determined by trading volume and price movements on global stock exchanges. However, market capitalizations can be misleading, as many investors judge a company’s worth according to the value others place on it during trading hours. This leads to a lack of fundamental and technical research, which can result in foolhardy investment decisions. Positive cash flows, low levels of debt and attractive enterprise values are far more effective means of evaluating a company than both market capitalization and price/earnings ratios. In the case of GameStop, the company has continued to maintain an impressive positive flow of cash, even during the vicious short seller raid, a roughly 50 percent reduction in total long term debt since January, and an EV/EBITDA (earnings before interes, taxes, deprecation and amoritzation ratio) of 3.91 far below the Computer & Electronics Retailers industry average of 7.94. These three metrics shine lights on GME in a way which starkly contrasts the bearish sentiment of short sellers.
In June, GameStop announced the elimination of its quarterly cash dividend payment to investors. Though the stock plummeted 30 percent following the news. This was one of the very few correct decisions made by the company’s management team in recent years. Eliminating the dividend payment may not be a pleasant optic, but in the case of GameStop, it is the most efficient way to lower the company’s debt levels even further. Since dividend payments are simply a distribution of revenue to existing shareholders, using such cash to instead pay down outstanding debt is a far better use of assets for the given time. So if GameStop is able to successfully turn around and return to profitability, the dividend can easily be reinstated. Debt is a silent killer of companies. As a result, it is best to pay down any debt whenever possible. Instead of using new debt to finance existing liabilities, GameStop is using money it has on hand to achieve such a task.
GameStop has the ability to stage a comeback of unprecedented proportions. With the stock being so heavily shorted by sheepish investors, a recovery in the foundation of GameStop’s business model and execution would result in an enormous short squeeze, which in turn would lead to massive gains in the price of its stock. And as foot traffic into GameStop locations across the country has increased at better-than-expected rates for the current fiscal quarter, such a recovery appears to already be brewing, making the stock an attractive buy at this moment in time.