GameStop Turns a Profit: So What? It’s Still Not Worth Investing

Key Points

• GameStop turned a profit, but the underlying cause isn't exactly good news for investors.
• The company's cash balance generates sufficient cash flow to sustain operations, but operations are losing money.
• The stock is overvalued and could lose 50% or more of its value. 

GameStop NYSE: GME shares edged higher following its Q3 release, but so what? The report included a surprise profit, but the underlying cause and business metrics align with the trend. This company continues to contract and is consuming itself at investors' expense. It only profited in Q3 because of increased interest income related to its cash buildup.

The company raised billions in 2024, shoring up the balance sheet for an as-yet-to-be-determined turn-around effort.

The ultimate takeaway is that shareholder value is eroding, the underlying business loses money, and the stock is ridiculously overpriced. The only thing for certain is volatility, but the market is skewed toward lower prices, which is the most likely scenario in 2025. 

GameStop’s single bullish factor is the cash balance, which swelled by 500% over the last year. Now over $4.6 billion, the interest income on the balance is enough to sustain the operation until something else happens. However, with the underlying business losing money and net income slim at $17.4 million, the company has little room to maneuver without eating away at the balance.

The bad news is that the build-up of cash is due to share sales, which increased the share count by 23% on average in Q3 and the issued amount by 43%, severely impacting shareholder value. The net result on the balance sheet is a 2.8x increase in total equity but a decrease in book value to roughly $11, more than 50% below the market price leading into the report. 

GameStop: A Business Circling the Drain

GameStop’s Q3 results are mixed relative to consensus forecasts reported by MarketBeat, with revenue below targets and earnings above. The cause for bottom-line outperformance has been addressed; the cause for the top-line weakness is a contraction in all three retail operating segments, led by a 27% decline in the core hardware business. 

Given the gaming industry trends, GameStop’s total sales are now a fraction of what they once were and are likely to continue contracting. The game makers face headwinds, including the rising cost of development and diminished post-pandemic interest, while consumers spend more time outdoors, tired of ads and relentless in-game expenses.

Video games are still popular, but the market is normalizing to its core, and core gamers are more price-conscious than ever. 

The business margin is still poor, and there are risks to the profit outlook. The company reduced its SG&A expenses, which were insufficient to produce an operating profit. The operating loss topped $33 million, or about 61% of the interest income, more than doubling as a percentage of revenue compared to last year.

Regarding the risk, the FOMC is on track to reduce rates in 2025 if at a lesser pace than once forecasted, effectively reducing the company's ability to generate income from interest payments. In this scenario, GameStop has bought some time, but the clock is still ticking, and a turn-around plan needs to be established. 

The Sell-Side Poses Risks for GameStop

Sell-side interest in GameStop is mixed, with only a single analyst rating the stock and that at Sell, while institutional interest is the opposite. The institutions have bought this stock on balance throughout 2024, supporting the market within its trading range, and Q4 activity ramped to a high that aligns with the stock price rise to new highs.

The market is now above one resistance target but still below the critical target at the range’s mid-point. If the institutions keep buying this stock, it will likely rise; the risk is that they won’t and may even begin to sell, adding downward pressure to the market.

Regarding short interest, the ratio is down from its peak, due primarily to the increased share count, but it rose at the end of November as short-sellers sold into the rally.