Stuff GameStop in Your Stocking

GameStop's motto is "Power to the Players." But given this video game retailer's stock price over the past year, it might as well have been "Power to the Investors."

At a time when retailers are on pins and needles about the current holiday shopping season -- and have become high-risk in general in a slowing economy -- GameStop is cruising through obstacles like Tony Hawk doing 360s around a skateboarding half pipe.

The stock (symbol GME)struggled along with the overall market on December 11, sinking 3.1%, to $58.12. The Dow Jones industrial average fell 2.1% to 13,432.77. But for all of 2007, share prices have more than doubled.

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GameStop, headquartered in Grapevine, Texas, operates 5,000 stores in North America and Europe, selling new and used video-game hardware, software and accessories for computers and gaming systems.

Cutthroat competition among Microsoft, Sony and Nintendo for console supremacy doesn't faze GameStop, nor does it care if Electronic Arts's Madden NFL blows past Activision's Guitar Hero III -- the stores sell them all. The stock has a market value of nearly $10 billion; the company's annual sales will approach $7 billion for the fiscal year that ends in January.

If you're near Silicon Valley and want to see what GameStop is all about, go to the new 4,000-square-foot combination store and tournament center in San Jose and rub elbows -- or remotes -- with football fanatics at the inaugural Madden NFL '08 tournament on December 15. There, customers will compete on 24 networked gaming stations with plasma monitors to win a $1,000 GameStop shopping spree.

It's all part of the "shopping-as-entertainment" motif that sets GameStop apart, says Zacks Equity Research analyst Rob Plaza. "Best Buy used to have that buzz. Anytime you go to a GameStop, it's a destination -- you want to go, see what's available and talk to the guys behind the counter."

If you're an investor and want to see what GameStop is all about, just look at the numbers. The company in November reported third-quarter earnings that blew through analysts' estimates, with earnings per share having tripled from the same quarter a year earlier.

Analysts expect the company to earn $1.66 a share for the year that ends in January '08, and $2.11 the following year. Zacks is forecasting annualized earnings growth over the next five years of 25%, well above Zacks' estimated five-year forecasted growth rates for Circuit City (15%), Best Buy (15%) and RadioShack (9%).

A sign that the stock has arrived in the mainstream: On December 5, Standard & Poor's announced that GameStop would replace Dow Jones, which is being acquired by Rupert Murdoch's News Corp., in the S&P 500-stock index.

Not everyone's a believer. Short interest -- bets that the share price will fall -- has been rising in GameStop, and would-be profit-takers are plentiful, given the stock's stunning rise. But naysayers could be sorely disappointed this holiday season.

"People who are shorting will get their rear-ends kicked at Christmas," says analyst Michael Pachter at Wedbush Morgan Securities. "GameStop will report holiday sales on January 2 and the stock's going up," he predicts.

Even in shaky economies, video-game industry sales have historically been immune to consumer-spending worries, analysts note. And GameStop is well positioned anyway because customers can fatten their wallets by trading in their old consoles or used game titles to help fund new purchases. What's more, because used equipment and video games sell at a discount, they're particularly appealing to a financially stressed holiday shopper.

Finally, worries about lead-tainted toys will only enhance the appeal of video games, and retailers like Best Buy and GameStop stand to gain, says Michael Souers, specialty retail analyst at S&P.

But GameStop is not a stock to buy and hold -- it's a stock to buy and watch. It tends to follow the video-game industry's cycles, which begin when new consoles are introduced. The current cycle began in November 2005 with the introduction of Microsoft's Xbox 360, followed by last year's introduction of Sony's PlayStation 3 and Nintendo's Wii.

Zacks expects the cycle to last through 2009, as consumers upgrade to these consoles, and purchase the next-generation games that go with them. Others see a peak in console sales in 2008, after which unit sales will decline and console prices will get cheaper. For GameStop, that would likely translate into a decline in the growth of sales for stores open at least a year.

Yet such a decline isn't the downer for the stock you'd think it would be. That's because as same-store sales start to slow, profit margins for GameStop tend to expand, as more of a share of total sales goes to software in general and then used software in particular.

"GameStop would much rather sell $300 in used games than $300 in consoles," says Pachter. That's because the margins on hardware sales are just 7.5%, compared with 20% to 22% on software sales and a whopping 50% on used software sales.

The unanswered question is how investors on Wall Street will look at the stock in 2008: as a company whose sales growth has peaked (at least for this cycle) or as one at whose margin expansion has just begun.

Zacks, which rates the stock a buy, says it could see $65 a share within the next six months, while S&P, despite being a big fan of the company, says the shares are fully valued. Wedbush's Pachter says $69 is a reasonable 12-month target for the stock but adds that a stock as volatile as this one could give investors an opportunity to add to positions -- or establish new ones -- more cheaply in 2008.

Believe me, I know first hand how tricky such timing can be. Last year, as I shopped for Christmas presents for my teenage sons -- who've wheeled and dealed at our local GameStop on more occasions than I care to count -- I thought I'd buy them shares in the company. In the end, I decided a company with a dividend reinvestment plan might be a better option (GameStop pays no dividends.)

Had I bought shares a year ago, at $28, my sons' take would have been more than $30 a share, or a gain of 108%. That would have given them quite a holiday shopping budget to spend on old Mom this year. Sigh.