This past weekend I watched a clip from Bloomberg with an interview of a fellow in Ireland who made his first investment ever. He took his entire $300 savings and bought two shares of GameStop. His rationale was that someone had given him a tip. I hope it works out for him. Now don’t get me wrong, I think the concept of owning stocks (directly or through an exchanged traded fund) is an amazing thing. Here with very little cost, we can become owners in a business with a claim on future earnings. Very little cost and time are required: open and account, click ‘buy’, and boom. But it’s a two edged sword. The process is so much easier than actually buying a business. The young investors on the Reddit forum Wall Street Bets like to say they are taking power back from Wall Street. Yes, it’s true, that trading platforms where they can buy shares with $0 commissions gives them ‘the opportunity’ to participate. But, does it give them the wherewithal?

There are two ways to think about owning stocks. You can think like an investor and evaluate the purchase just like you would if you bought an entire business (fundamental analysis). Or, you can invest in the stock based on speculation that it will go up or down. There may even be some rationale for this type of speculation such as looking at chart patterns (technical analysis). As it turns out, there is evidence that both fundamental and technical factors can give us clues about the future return for a stock. Personally, the framework I like to use is fundamental analysis which tells me what to buy or sell. Technical analysis gives me some clues about when to buy or sell.

Before we go further, it is important to highlight that the stock market has a huge number of participants. Insurance companies, pensions, hedge funds, stock funds and retail investors just to name a few. The stock market is like a voting machine. Investors have differing opinions about the value of the company and vote by buying or selling at a certain price. Make no mistake, when we are in competition with other investors in this regard, it is hubris to think that any one of us have a substantial advantage. For this reason, an investor holding a basket of securities at low expense may be well served. Owning a diversified basket of companies, assuming you have done adequate homework can also be rewarding.
Here are the first 5 questions I would ask. These are all fundamental questions. We’ll save technical questions for another day. I haven’t done a lot of research on GameStop, but I’ll throw in a few thoughts on the questions to advance the discussion.

Question 1: What market does the company participate in and what are the growth prospects?

GameStop primarily sells game consoles and game disks (new and used) primarily through retail stores. The company has over 5,000 stores and began in 1984. Defining the market and the prospects is difficult. The gaming market is growing rapidly. At the same time, there is a shift away from physical disks and retail purchasing to online gaming. One of the big problems with valuing GameStop is that the rate of decline in console sales with disks attached is uncertain.

Question 2: What is the company’s unique and sustainable value proposition?

GameStop’s large footprint of retail stores and consistent experience give them an advantage. They have a rewards loyalty program that keeps customers coming back for more. You can try the games and consoles in the retail store before buying. Is online gaming and direct purchasing of consoles and games ever going to replace the retail experience entirely? This is a difficult question to answer.

Question 3: How much cash flow and earnings does the company generate? How will this change over time?

If I’m going to buy a business I want to know what kind of cash flow and profits it generates. Understanding how to read an income statement, balance sheet and cash flow statements is the starting point. I really don’t like the idea of anyone buying a stock who can’t read financial statements. Yes, we can rely on an analyst’s report but, without understanding the statements, we can’t really evaluate where we may agree or disagree with a specific opinion. Anyone can get the financial statements for a company on Yahoo. For example, here is where you can find GameStop financial statements.

A quick look at GameStop’s financials should give one pause. The company generated just about zero profit in 2018 on sales of $9.2 B. In 2019, sales declined more than 10% to $8.285 B. The company generated a loss of $754 M before tax. The year ending 1/31/2020 saw revenue decline to $6.466 B, another 22% from prior year. This business is not heathy and a turn-around of epic proportions will be required to justify the company’s current valuation of $17 B. (stock @ 244.50 on 2/1/2021).

Question 4: What is the fair value of the stock, given the business prospects?

There are many techniques for valuing a business. Discounted cash flows attempt to look at the estimated earnings and cash flow over time and compute a value taking those cash flows back to present day. Comparison of multiples to similar companies is another way to value a company. We may look at price to earnings (P/E). When a company isn’t generating any earnings, other metrics like price to book (P/B) or price to sales (P/S) are also helpful.

The process of doing valuation analysis takes time. The estimates of the value will range dramatically based on the estimates. We don’t have the space to get into the details here, but without putting a value on the business using some kind of economic rationale would mean a purchase is doing nothing more than speculating on sentiment or technical factors.

Question 5: What valuation do the analysts give the company? If my estimate is different, why?

Analyst’s estimates for the company are very useful. These analysts are professionals and they have access to the company. The look at the company’s strategy and do detailed analysis of pro forma (future looking) financial statements and valuation analysis to arrive at an estimate for the company.

One website that provides a good deal of valuation metrics and analyst estimates can be found at finviz. See this link for GameStop.

The third block down has a summary of recent analyst forecasts for the stock. The estimates range from $5 / share and a SELL from The Benchmark Company to $33 / share from the Telsey Advisory Group. Even with the $33 target, Telsey gives the company an ‘Underperform’ rating.
It’s interesting to note that the analyst coverage is pretty thin and we don’t have any of the top analysts making any recent recommendations. The last Bank of America / Merrill Lynch changes was an ‘Underperform’ rating and a price target of $2.50 back in Aug of 2019.

Prior to the frenzy on Wall Street Bets there was a very high short position in the stock and some believe the crowd on Wall Street Bets was simply trying for a short squeeze. Maybe so, but either way we can see that the range of targets is very wide: $5 – $33. The analysts don’t have consensus. Now, the short interest has come way down. The stock closed down today at $227. I can’t stop and wonder what the first time investor is supposed to do now with his stock that started the year at $18.90, spiked to $483 and has now dropped back to $227. I suppose the company could somehow re-invent itself in some way we can’t imagine. Say it’s worth 4X the highest analyst estimate, but even at $120 it still is almost 2X above an extreme valuation range.

Did the young first time investors outsmart the hedge funds by buying a company worth $5 – $33 by paying over $200 for a share? Time will tell. What is clear is that a simple internet phone trading app (RobinHood), with $0 trade commissions, online trading communities, very low interest rates and easy credit through margin loans has created pockets of speculation that rival just about anything that has happened in history. The Federal Reserve says they are doing the right thing by massively increasing the money supply and keeping interest rates at zero. I’m not so sure.