It seems like all anyone has talked about for weeks is GameStop (NYSE:GME) stock. Never in a million years did I think GameStop would be relevant on Wall Street in 2021. But thanks to a crazy group of speculative Reddit traders, GameStop has largely been responsible for significantly disrupting the market and crushing at least one billion-dollar hedge fund.
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Is there a case to be made for a long-term GameStop turnaround story? Absolutely. It is possible that short squeezes and market manipulation could push GameStop to new all-time highs in the coming weeks? Sure. If you are a trader or short-term speculator that wants to try to time the extreme swings in GME stock during that time, I say Godspeed. But there is absolutely no reason to be holding GME stock as a long-term investment at its current level.
GME Stock Short Squeeze
The near-term GME stock short squeeze trade has been covered to death in the media. GameStop is one of the most heavily shorted stocks in the entire market. Its reported short interest as a percentage of float was recently as high as 139.5%.
A crew of retail traders identified GME stock due to its large short interest, much of which was held by institutions and hedge funds. The r/WallStreetBets Reddit community, which had roughly 2 million members a week ago, decided to take a run at triggering a short squeeze in GameStop.
By buying near-dated, out-of-the-money call options, retail traders were able to generate a gamma squeeze. A gamma squeeze occurs when institutional brokers and investment banks that sell these call options to retail traders essentially become short the underlying stock. As part of their risk management, those investment banks and brokers will then turn around and buy the stock to negate their short exposure. That buying drives up the share price, potentially creating a positive feedback loop.
In a stock like GameStop, the gamma squeeze can then lead into a short squeeze. The stock price starts to rise so fast that short sellers are logging massive losses. They are forced to exit their positions by buying stock. More stock buying generates higher stock prices, which creates another positive feedback loop.
These two phenomena are how a stock like GME stock has skyrocketed from a 52-week low of $2.57 to an all-time high of $483 in a matter of months.
GameStop Turnaround Story
There is no question GameStop’s business is in trouble. Even before the pandemic, GameStop reported a 3% drop in revenue and a $673 million net loss in 2019. In the most recent pandemic quarter, revenue was down 30.1% from a year ago. The business generated an $18.8 million net loss.
GameStop’s annual revenue peaked back in 2012 at $9.55 billion. As video game purchases have followed much of the rest of the economy in shifting offline to online, that revenue had dropped to $8.28 billion in 2019. Then the pandemic hit, which crushed all mall retailers, including GameStop.
But there is hope for GameStop enthusiasts. In 2020, Chewy (NYSE:CHWY) co-founder Ryan Cohen took a more than 12% stake in GameStop. Cohen’s presence renewed hope for GameStop bulls like Hedgeye that the company could transform into an “online destination for the gaming community.”
A shift in GameStop’s model from a brick-in-mortar mall retailer into an online gaming community could certainly save GameStop. But that transformation will take time. That transformation will take money. It may not even work. And even if it does work, how much upside will it produce?
“COVID has helped accelerate GME’s online sales to 30% of total from under 10% but we see a higher mix to online as a negative for earnings,” Bank of America analyst Curtis Nagle says. “Very simply, the more business that shifts from in-store transactions, the more difficult it will be to sell high margin pre-owned and collectibles merchandise which accounted for 46%E of gross profit dollars in 2019.”
In other words, GameStop needs to transition to an entirely different business model to stay alive. And that business model is likely a less profitable one than the current one.
Bank of America has an “underperform” rating and $10 price target for GME stock.
How to Play It
The short squeeze worked. WallStreetBets and GameStop will now be discussed in college finance classes from now until the end of time. At this point, the squeeze is probably over given the stock has dropped from $480 all the way back down to around $100. Maybe not, but probably.
I’m sure there will still be plenty of bounces in coming weeks. If you are a trader that wants to get in on the action, go for it. Just be careful.
If you are a long-term investor, GME stock is a dumpster fire of an investment. The underlying business thesis is nothing but a pile of question marks at this point. And remember that even most GameStop bulls came out at much lower prices. Hedgeye said to go long GameStop when it was under $15. It was a home run call, for sure. But how bullish would they have been if GameStop were trading at $100 at the time?
I don’t know just how low GameStop shares will end up going in the long-term. Maybe $10. Maybe $15 or $10. But the point is that GME stock is a trader’s treasure and a long-term investor’s nightmare.
On the date of publication, Wayne Duggan did not have (either directly or indirectly) any positions in any of the securities mentioned in this article.
Wayne Duggan has been a U.S. News & World Report Investing contributor since 2016 and is a staff writer at Benzinga, where he has written more than 7,000 articles. He is the author of the book “Beating Wall Street With Common Sense,” which focuses on investing psychology and practical strategies to outperform the stock market.
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