GameStop Bulls Are Making These 3 Mistakes | The Motley Fool

GameStop ( GME 3.52% ) has become one of the more closely followed meme stocks since late 2020. Once a penny stock, it briefly spiked higher as a short squeeze and social media popularity sent it to new highs.

However, the stock quickly gave most of its gains back. Despite lingering popularity, its stockholders continue to make three critical mistakes in evaluating its future.

Image source: Getty Images.

1. Looking at the wrong metrics

Many GameStop traders made profitable, short-term trades last year by following two metrics: shares outstanding and percent short interest. Through these, they found a way to pool together, bid the stock price higher, and force short sellers to cover their short trades at tremendous losses.

GME Shares Outstanding data by YCharts

However, such unusual circumstances do not reflect the company’s long-term fundamentals, particularly when it comes to revenue and earnings. GameStop reported revenue of just over $6 billion, an 18% improvement from year-ago levels when pandemic-related closures still hampered revenue. Still, that remains well below 2018 revenue levels when the company brought in $8.3 billion.

Additionally, the company continues to post increased negative earnings. Losses for fiscal 2022 rose to $381 million, up from $215 million the previous year. Analyst forecasts point to modest annual profits for the next two years — so modest that more bad news could turn those forecasts negative. While losses are more forgivable for a start-up, they do not bode well for an established firm whose revenue peaked years ago.

2. Confusing survival with prosperity

One positive consequence of the stock-price appreciation is that it allowed the company to issue shares at much higher prices. This has given GameStop the breathing room it needed to revamp its business. To this end, it has gone aggressively into online game sales and has begun to build a business in collectibles. It plans to launch a non-fungible token (NFT) marketplace by the end of the second quarter.

However, name recognition appears to be its only competitive advantage. Indeed, GameStop can aggregate games from multiple manufacturers on one site. Still, customers can find the same games at the same price on the manufacturer’s sales site. Consumers also have other choices in the collectibles and NFT businesses, boding poorly for the retail stock.

Moreover, the number of stores has continued to fall, indicating that low-performing assets remain a problem for the company. Also, with the stock having risen more than 2,000% since August 2020, one can safely assume investors have priced the improvements into the stock. This leaves no predictable path for the stock to move higher.

3. Reliance on emotion

Finally, investors must understand the powerful but fleeting influence that emotions can have on stocks. As shown historically by the dot-com boom or the depths of the 2008 financial crisis, emotion can profoundly affect the market, both positively and negatively.

One only has to look at GameStop’s chart to quantify the effects of emotion. GameStop went from a low of $4 per share in August 2020 to a high of $483 per share in January 2021 and has experienced considerable volatility since that time.

Sentiment continues to run high. However, it never again reached that high and has fallen by nearly 85% from its peak as of the time of this writing. Since revenue and earnings will probably not justify a $400+ per share price anytime in the foreseeable future (if ever), many investors appear destined for losses.

What to make of GameStop stock

GameStop can probably survive as a company. However, its prospects for moving beyond a survival mode appear questionable at best. Its future will place it in markets where name recognition will serve as its only discernible competitive advantage, making it a stock that could sabotage your portfolio. Despite continuing popularity, GameStop holds no obvious catalyst that would prompt further buying at current prices.