Is GameStop a Diamond in the Rough or Will Shares Continue Crashing?

Is GameStop a Diamond in the Rough or Will Shares Continue Crashing?

November 21 was not a good day to hold shares of GameStop , the $5.7 billion specialty retailer of video games and consoles. After reporting earnings that smashed analyst estimates, shares of the video game seller/reseller fell nearly 7% to close at $48.80 per share because of low fourth-quarter estimates. The drop marks a rare event for the company, which has seen its shares sour 118.8% from their 52-week low of $22.30 apiece. With the dip in share price, is now the time to buy shares of the company at a discount, or is this drop likely a sign of worse things to come?

Earnings destroyed analyst estimates!
While the drop the company experienced today would give the impression that it fell short of analyst estimates, the true situation couldn't be further from the truth. During the third quarter, the company reported revenue of $2.11 billion, 18.8% higher than the $1.77 billion it reported in the same quarter last year, and 6.4% higher than the $1.98 billion that analysts estimated. According to the earnings release, the primary driver behind the company's increased sales was due to comparable store sales rising by 20.5%.

In comparison, Best Buy , another specialty retailer, saw its revenue fall by 0.2% from $9.38 billion in the third quarter last year to $9.36 billion this quarter. According to the company's earnings release, the decline in revenue came about as its international sales fell 11.3%, 6.4% of which was chalked up to a decrease in comparable store sales. Though, in all fairness, the company increased revenue domestically as comparable store sales rose by 1.7%.

However Game Stop didn't stop at crushing revenue estimates! It also beat out earnings per share estimates by a penny, coming in at $0.58. This is far higher than the -$5.08 per share reported last year (due to an impairment charge), but results were negatively affected by a rise in cost of goods sold. For the quarter, the company saw its cost of goods sold rise from 68.6% of sales to 71.6%. According to the company, the margin decline was due to lower returns on both new video game software and pre-owned video game products.

Similarly, earnings per share improved for Best Buy, but the bar for it to jump was a fairly low one. For the quarter, the company saw earnings per share come in at $0.16, 33.3% higher than the $0.12 analysts expected and much higher than the -$0.03 the company reported in the same quarter a year ago. Though revenue decline, management brought in significant cost savings by reducing selling, general and administrative expenses.

Moving forward
Although GameStop's earnings for the quarter blew away what Mr. Market expected, there was one piece of news that is responsible for sending shares plummeting. For the company's fourth fiscal quarter, management announced that they believe it will earn between $1.97 and $2.14 per share, below the $2.15 that analysts were expecting. For the year, this would imply earnings per share in the range of $3.08 and $3.25. This would imply a price/earnings ratio of between 15.02 and 15.84, which suggests the company is neither dirt cheap nor expensive.

Foolish takeaway
This past quarter, GameStop destroyed Mr. Market's expectations, something for which investors should be pleased. However, the announcement that its fourth quarter will miss by as little as a penny was enough to outweigh the fact that it has been growing rapidly. Given all the facts, such a drop is not likely justifiable, but the beauty behind it all is that it presents the Foolish investor who believes the company to be undervalued the opportunity to take a stake at a discount.

Furthermore, while other specialty retailers like Best Buy are struggling with declining revenue, the P/E that GameStop is offering prospective and existing shareholders isn't extreme. Though the fear that downloadable content could crush the business has weighed against the company for years, there is no sign as of yet that it has significantly harmed its performance. Only time will tell if it ever will, but if it does not, then GameStop might be considered a diamond in the rough.

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Daniel Jones has no position in any stocks mentioned. The Motley Fool owns shares of GameStop. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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