Shares of GameStop, near a two-year low, look like a buy

Walmart's (WMT) announcement earlier this month that it would slash prices on video games by up to 20% sent a shiver through the video-game industry. Shares of Grapevine, Texas-based GameStop (GME), a top game retailer, fell 8.3% on the news to a near two-year low. They haven't recovered since. But the decline could provide investors with an attractive buying opportunity.

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%.

Read Full Story
  • DJI25628.90-623.30-2.37%
  • NIKKEI 22520258.92-451.99-2.18%
    Hang Seng25452.22-727.11-2.78%
  • USD (PER EUR)1.11-0.0005-0.04%
    USD (PER CHF)1.03-0.0014-0.14%
    JPY (PER USD)105.430.03900.04%
    GBP (PER USD)1.23-0.0011-0.09%