I want to talk about GameStop (GME), its share price, its fourth quarter earnings report and the company’s outlook. But I also want to talk about the differences between thriving companies and failing companies, and the murky in-between.
I’ve spent many years studying signs of risk in corporate balance sheets and stock ratios. I’ve sold stocks that showed signs that revenue or net income or debt levels were deteriorating. And there have been lots of other famous, ugly corporate scenarios that I warned investors about while they still had plenty of time to preserve capital:
• On October 27, 2017, when it became clear that General Electric (GE) was immersed in cash flow problems, I predicted that the company would have to cut the dividend in half. On November 13, 2017, General Electric cut its dividend in half.
• I warned investors a dozen times about JC Penney (JCP), beginning in February 2013 when the share price was $17, saying “Inventory is falling and accounts payable are rising.” The company’s financial situation famously deteriorated, and the current share price is $2.99.
• In August 2016, I gave a presentation to investors at Cabot’s annual conference. I talked about the risk of corporations carrying too much debt. Macy’s (M) was featured prominently in my PowerPoint presentation. Coincidentally, on that very day, Macy’s announced that it would be closing 100 stores!
• In August 2014, I warned investors that Target Corp.’s (TGT) expansion into Canada was not working out as planned. In January 2015, Target announced that they would close all of their Canadian stores.
• In March 2014, after making a tremendous amount of profit on shares of Valeant Pharmaceuticals (VRX), I told investors to use stop-loss orders because earnings growth was slowing and debt levels were rising. At that time, the share price was $143.46. As the financial problems deepened, they were compounded by a revenue scandal. I told investors several more times in 2014 and 2015 that it was not too late to sell VRX, and that the share price would assuredly continue to fall. Today’s share price is $15.89.
Debt problems, cash flow problems, expansion problems, profitability problems, inventory problems … they all point to potentially falling share prices.
Back to GameStop—a company that is experiencing none of those corporate problems, yet whose share price keeps falling. At this point the price/earnings ratio (P/E) is shockingly low at 4.2, and the very safe dividend yield is 12.1%. Yes, the company has been working on transitioning its revenue streams within a variety of different product categories. And if you listen to yesterday’s webcast, it’s clear that company leadership continues to put sales, gross margin, product mix, marketing, merchandising and SG&A under a microscope in an effort to continue maximizing revenue and profit; and they provided tremendous detail about those efforts.
Management also mentioned several times during the webcast that they are committed to returning excess cash to shareholders. (Translation: the dividend is in no danger of being reduced, and there’s plenty of cash flow to cover the dividend payouts.) Additionally, GameStop reported a tremendous fourth quarter, which exceeded consensus earnings estimates on both revenue and net income.
In one webcast anecdote, which I found absurd and amusing, an analyst asked about future store closures. GameStop management responded that they’d already closed all of their unprofitable stores, and the only way to close more stores would be to begin closing those that are profitable. And no, they’re not going to do that.
Yet the share price continues to fall. I could tell you to sell GME from your stock portfolio so that you don’t have to look at it and cringe anymore. Or I could tell you to buy more shares of a dirt-cheap company, while locking in a 12.1% dividend yield. Or I could tell you that GameStop would make a fantastic takeover target, because I do believe that, and I’ve got a good track record of identifying takeover targets.
What I cannot tell you is that the company is floundering and that everybody should head for the hills.
I am the first to admit that I am stymied by the stock’s low price and low valuation when compared to the company’s financial realities. Do I tell everybody to sell? Whatever is happening with the company and the stock, it’s a situation that I’ve never encountered, so I’m going to adjust my normal thought process and tell people to sell half their shares, since it’s possible that I’m very wrong about my assessment of GameStop. SELL HALF.