Why I'm Not Buying GameStop

Why I'm Not Buying GameStop

In past decade, bookstores, record shops, video rental shops have virtually disappeared -- driven out business by Amazon.com, Apple, Netflix, etc. Only one form of popular media is still widely sold in dedicated, physical stores: video games. That business is dominated by GameStop , which has proven to be a savvy operator. Its stock has returned more than 80% this year, and investors are excited about the recent releases of the PlayStation 4 and Xbox One consoles.

However, it's one stock that I wouldn't touch. Digital downloading of games is on the rise and eventually GameStop's stores and used-game business will become obsolete. As a result, the company's intrinsic value is likely significantly below today's trading price.

Why I'm not buying GameStop
It's taking longer than expected, but eventually game distribution will be fully digital -- a cheaper, more efficient distribution model with potential benefits for both video game makers and players. The shift is already happening. According to a report by the NPD Group, digital game sales surpassed physical game sales last quarter. Last quarter, Electronic Arts and Activision Blizzard respectively generated 65% and 59% of revenue from digital channels.

The only question is how long it takes for the industry to completely transition to digital distribution. My best guess is that it will probably happen within the next 10 years. That will cause GameStop's profits from new and used games to evaporate. Unless management miraculously transforms the company's business model, GameStop will cease to exist.

Based on my investment approach, that's a total deal breaker. My goal in buying a stock is hold it for a very long time -- five years, 10 years, or even longer -- and I evaluate stocks solely based on the future profits they can generate relative to my purchase price. GameStop is trading at 14-times earnings today, with a 2.2% dividend. If the company is likely to fail within the next 10 or even 15 years, it's impossible to justify buying at today's price based on that criteria.

Foolish takeaway
I don't know how GameStop's stock will trade over the next quarter or even the next few years. But over a longer period of three, five, or 10 years, I'd be very surprised if investors made a profit.

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The article Why I'm Not Buying GameStop originally appeared on Fool.com.

Brendan Mathews owns shares of Apple and Amazon.com. The Motley Fool recommends Activision Blizzard, Amazon.com, Apple, and Netflix. The Motley Fool owns shares of Activision Blizzard, Amazon.com, Apple, GameStop, and Netflix. 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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Originally published