2 Reasons GameStop Will Pop and 4 Why it Won't

Key Points

• GameStop reported a better-than-expected quarter, but shares may not rally on the news. 
• The margin widened, but losses and cash burn remained. 
• The sell-side, including analysts, institutions, and short-sellers, have no love for this stock. 

GameStop NASDAQ: GME reported Q2 earnings, and shares are moving. While the market is up in early premarket trading, there is no guarantee the market will continue to rally. As bullish as the bulls are, the bull-case thesis is sketchy, and the bears are equally sure they’re right.

The bottom line is that GameStop’s market is driven by fear, greed, and emotion more than fundamentals, which is a recipe for volatility. While there is reason to believe the stock will continue to rally, there are more reasons to think it won’t and in the end, the only traders who will win are the 1’s trading volatility.

GameStop Has Better Than Expected Quarter 

The #1 reason GameStop may rally is that it had a better-than-expected quarter. The top and bottom line results were better than expected, driven by mix and internal efforts to reposition and control costs. Revenue reached $1.16 billion, up 1.8% from last year and $0.020 better than expected.

The margin of outperformance is slim but a telling indicator for this struggling company. Hardware sales were relatively flat within the top-line data, and weakness within the collectibles market was more than offset by strength in software sales. Regardless of the company’s growth outlook, this data suggests stable business over the coming quarters. 

GameStop Margins Widened Significantly 

The #1 bullish highlight from the Q2 report is the margin. The company was able to widen the gross and operating margins due to pricing, mix, and internal efforts at efficiency. The gross margin improved by 140 basis points while the operating margin by 640 to cut the quarterly loss by nearly 100%.

Quarterly losses came in below $3 million compared to last year’s $100 million+, which has the company remarkably close to regaining profitability. However, GameStop may not rally further on this data because losses are still present, and the outlook for profitability is hazy at best. 

The Balance Sheet and Sales Mix Aren’t  Promising 

GameStop’s balance sheet is still in solid condition; there is no immediate danger of collapse, but the stats are not promising. The company’s cash burn continues despite the margin improvements; cash is down YOY, assets are down, inventory is down, and receivables are down while liabilities have increased and shareholder equity has decreased.

This is no catalyst for a rally and a factor that could weigh on the market indefinitely. 

Regarding mix, the company’s mix is largely responsible for the quarterly strength, but the details belie the headline. Hardware sales are relatively flat compared to last year, but software sales are up. This is a sign of gamers leaning into new ways to enjoy old machines more than strength in the market. And collectibles?

The company’s growth avenue and margin supposed margin driver? Collectible sales are down 24% YOY as consumers of such goods cut back on discretionary spending. That trend is unlikely to change soon. 

The Analysts Have No Love for GameStop 

The #1 sign that GameStop won’t rally or be able to hold the gains if it does is the sell-side. The sell-side, represented by the analysts, has no love for this stock and rates it a strong sell (based on a single rating), and the price target is in the single digits.

This provides no support for the market and leaves a glaring weakness should the short-sellers decide to lean back into the trade. As it is, the shorts have sold 20% of the market, and institutional selling has also picked up recently. 

The charts of GameStop are promising. The market shows a potential bottom that today’s action may confirm. The question is if the market will continue to move higher from here and what happens when it reaches critical resistance. Critical resistance is near $21.50, and the 150-day EMA has pushed the market lower over the past year.

If the market can not rally higher from the open today, the downtrend will continue, and new lows will soon be set.