Is GameStop’s 80% Rally a Sign of Small Caps Returning?

Key Points

• GameStop is looking to make a comeback after Twitter (now X) user "Roaring Kitty" boosted the company's future online.
• Sticking to the fundamentals, this 80% rally could be short-lived, as analysts see just as much downside from today.
• There are other better ways to play this "risk on" attitude given by markets.

The meme stock mania could be back underway, as shares of GameStop Corp. NYSE: GME have been halted after rallying by as much as 80% on Monday’s trading session. As it turns out, ‘Roaring Kitty,’ the Twitter (now X) user who started the first GameStop saga in 2021, has come back on Twitter to pump the gas on the stock’s future.

Those who feel like history could repeat itself and bring a more than 90% plummet after the recent hype, just like in 2021. However, there is a more significant trend underneath the fact that this $9 billion company is rallying so quickly, and it has to do with a market-wide rotation at hand. 

Expectations that the Federal Reserve (the Fed) could cut interest rates later this year have shifted investor interest into small-cap to mid-cap companies. These companies tend to outperform all others during periods of easy financing and a ‘risk on’ mentality. GameStop could provide investors with a wild ride, though other small companies may offer a safer ride based on this rally’s influence. 

Is There Substance to GameStop’s Rally?

Analysts think this chapter two of the 2021 fad, as a consensus price target of $5.6 a share, set by Wedbush as of March 2024, represents a net downside of 80.7% from where the stock has risen today. Fundamentally speaking, here’s why analyst sentiment hasn’t changed.

Following the company’s latest quarterly earnings release, covering up to the fourth quarter of 2023, analysts have good reason to believe the stock shouldn’t be this high. Starting with revenue, $1.8 billion represents a decline of 18% from the previous year’s $2.2 billion… Yikes.

Here’s where unsuspecting investors may get tricked by marketing stunts and creative accounting. The company reported a net income of $6.7 million, compared to a net loss of $313 million in the prior year. However, breaking down the quarterly financials, this income never came from business activities.

A net interest income of $49.5 million significantly skewed the bottom line. Investors can compare this to the company’s cash flow statement to really get to the actual business results. Cash flow from operating activities was an actual outflow of $11 million. Adding capital expenditures of $7.7 million brings the company’s free cash flow to negative $18.7 million.

If the company made a profit, there would be no need to dilute investors to fund further operations. Well, GameStop issued 1 million shares during the quarter. Now that the stock is becoming expensive again, further dilution could be expected, just as in 2021.

Investors could be better positioned by taking profits after this rally, avoiding GameStop altogether, or keeping it on the bearish watchlist for entertainment. Now, as markets are based on perception and influence, here’s how GameStop’s rally gives more opportunities elsewhere.

The Return of The Mid Caps

Above-average growth at discounts is how to play the market’s changing perception of risk. As buyers flooded a risky consumer discretionary business like GameStop, other sound companies could see the same buying pressure shortly as the Fed could start heating up the economy again. 

The driver? U.S. gross domestic product (GDP) growth peaked at only 1.6% in the past quarter. At the same time, inflation remained nearly twice the rate, bringing on what’s called stagflation (low economic growth with high inflation). To get out of this, the Fed may consider bringing these rate cuts sooner rather than later.

Based on these expectations, analysts at Sanford C. Bernstein see a valuation of SentinelOne inc. NYSE: S up to $37 a share, calling for a 70.5% upside from its current price. 

This target comes from the stock trading at only 70% of its 52-week high and projecting earnings per share (EPS) growth of more than 20% in the next 12 months. The company’s $6.7 billion size could push for more aggressive EPS growth.

according to analysts, stocks like CleanSpark Inc. NASDAQ: CLSK could see more than 200% EPS growth this year. The reason? When markets take on a ‘risk on’ mentality, alternative assets like Bitcoin could surge as they did during 2020-2022.

Because CleanSpark makes most of its money by mining and selling Bitcoin, investors may flood into the stock now that it trades at only 65% of its 52-week high. 

In addition, analysts at Chardan Capital see CleanSpark going as high as $26 a share. The stock must rally 60.5% from where it trades today to prove these predictions right. 

Bitcoin's recent rally, which reached a five-year high, is another sign of mid-caps returning. CleanSpark could be a leader among them.