Shares of GameStop, near a two-year low, look like a buy
Dec 11th 2009 4:40PM
Updated Dec 16th 2009 8:38AM
While Walmart's price cuts mean GameStop will do the same to remain competitive, the video-game company has a leg up: It doesn't sell just new games. In fact, almost half its profits come from trade-in offers, where consumers bring back their used games and the store then resells them. That's a higher-margin business.
GameStop also appeals to an audience that's unlikely to browse the shelves at Walmart -- hardcore gamers -- and GameStop typically sells a high share of the titles these players want. While Walmart will aggressively sell newly released titles, a Suntrust Robinson Humphrey analyst report points out that the top 50 video-game titles account for only about 30% of GameStop's overall new software sales.
The market outlook for video games should also give GameStop a boost. Demand for the wildly popular handheld gaming devices, such as the Nintendo DS, has been strong, according to SunTrust. Plus, the overall video-game industry is expected to perform well this holiday season. Given that GameStop also caters to value-oriented gamers -- it offers more than 2,500 games that sell for under $20 -- it seems well positioned to benefit from growing demand.
Good Growth Prospects
So far, all this seems to be giving GameStop an edge. While industrywide sales actually fell nearly 8% in November, GameStop bucked the trend with a 15% jump in new software sales.
Shares of GME now sell at a 67% discount to their five-year average of nine times trailing earnings. The stock's price-earnings-to growth (PEG) ratio, which measures how fast a stock is rising relative to its growth prospects, is just 0.57, a 50% discount to its five-year average.
GameStop isn't without risks. The weak economy could drag down video-game sales more than expected, and more people could opt to download games to their smart phones instead of shop at GameStop. But a more likely bet is that the shares will soon recover. According to Thomson Reuters consensus estimates, analysts believe that stock could reach $32 per share in the next 12 months, an increase of 45%.