Don’t Be Fooled by GameStop’s 4-for-1 Stock Split  

Like lambs to the slaughter, retail investors are buying up GameStop (GME) stock more than halfway through July 7 trading. The video game retailer’s shares are up more than 12%; as I write this on the news, it will split its stock 4-for-1 after the July 21 close. 

There are two schools of thought on stock splits. Some, like Silicon Valley-based Neil Macneale, swear by them. Macneale so favors them; he’s been publishing the 2-for-1 Newsletter since August 1996. Others, like Jensen Investment Management portfolio manager Kevin Walkush, believe the advent of fractional shares makes the stock split primarily psychological. 

My guess is that both men would tell you that the fundamental value of a business after splitting its stock does not change. 

Retail investors, especially the Reddit crowd, clearly feel otherwise. Virtually every stock split announcement in 2022 has been followed by higher volume and, in most cases, higher prices. 

In a down market, nothing works better than a good old-fashioned news story. That doesn’t change the fact that GameStop and savior Ryan Cohen still hasn’t fully articulated its transformational business strategy. 

Don’t be fooled by GameStop’s stock split news. It’s intended to take your eye off what’s important when evaluating its business. 

Here’s why I feel this way.

GME Stock Down Less Than S&P 500

Thanks to the stock-split news, GameStop’s shares are down 13.4% through July 7, more than 500 basis points higher than the index. Even better is its performance against the SPDR S&P Retail ETF (XRT), a collection of 100 equal-weighted retail stocks, which includes GME. It’s down almost 33% YTD. 
So, you could argue that GMEs become a bit of a defensive position more than halfway through 2022. 

Furthermore, as Silverlight Asset Management data shows from 1980 through July 7, over periods of varying lengths – one month, six months, one year, and 24 months -- the 1,461 S&P 500 stocks that have split have outperformed the S&P 500 as a whole. 

For example, the average performance over 24 months of S&P 500 stocks that have split in the past 42 years is 42.6%, more than double the index’s 20.9% return. I’m sure Neil Macneale would second these results. 

However, what a statistic like this doesn’t tell you, is the individual performance of all 1,461 stocks. Like the S&P 500, most of the performance in recent years was from a small number of companies. I’d bet dollars to donuts; the same situation exists with stock splits. 

If you’re an existing GME shareholder or considering buying, Silverlight’s data can best be described as confirmation bias. The 42.6%-to-20.9% outperformance is confirmation you’ve made the right call and GME is going higher. 

That’s not necessarily going to turn out to be true. 

Are GameStop’s Fundamentals Built on Smoke and Mirrors?

Don’t you think it’s strange that a company with a $10 billion market cap has only two analysts covering GME stock? And one of those analysts has a “sell” rating while the other has a “hold” rating.   

Why do you think that is? It’s not because its shares are trading too high. More analysts won’t suddenly come out of the woodwork once GameStop splits its stock later in the month. 

The answer is that GameStop has failed to provide sufficient data and information to investors to build their financial models to evaluate the company and its shares. Remember the adage: Garbage in, garbage out. 

The company reported terrible Q1 2022 earnings at the beginning of June. 

On the top line, sales grew 7.9% to $1.38 billion, from $1.28 billion a year earlier and 38.7% lower than Q4 2021. The sequential decline is an apples-to-oranges comparison because Q4 2021 is the big holiday shopping quarter. Over the past two quarters, GameStop has lost almost $321 million, or $1 in operating losses for every $11 in revenue.

Heading into its Q1 2022 earnings, Wedbush Securities analyst Michael Pachter predicted what would be said in the company’s conference call. 

“Maybe a mention of NFT, Metaverse and crypto wallet; no details on their strategy to actually make money; no explanation of how their deep relationships with console gamers gives them a competitive advantage with blockchain assets (NFTs) offered only in PC games; more promotion of their customer obsession; no progress in turning the retail business around,” Pachter told Barron’s on June 1.

According to Barron's, Pachter hit the nail on the head.

The worst part about its last few earnings reports is the declining gross margins. In Q1 2022, its gross margins were 21.7%. In Q1 2021, they were 25.9%. Its gross margins in 2012 -- its best year of sales on record with $9.55 billion -- were 28.1%. Between 2012 and 2021, they got as high as 30%.

Its pathway to profitability is headed in the wrong direction. 

Why Not Buy Williams-Sonoma Stock?

GameStop is currently trading at 1.44x sales and 6.16x book value. By comparison, Williams-Sonoma’s (WSM) P/S and P/B are 1.08x and 6.36x, respectively. 

However, the retailer of household goods and housewares has a gross margin of 44.2%, more than double GameStop’s. Interestingly, WSM’s return on invested capital in the trailing 12 months is also 44.2%. 

Ultimately, I fail to see why investors in this kind of environment would bet on something that’s 100% not a sure thing when they can buy a piece of a company that’s delivered market-beating returns for the past 15 years. 

Down 24% YTD, Williams-Sonoma’s current earnings yield (the inverse of the P/E ratio) is 12.7%, almost double its five-year average. 

Don’t be fooled by GameStop’s 4-for-1 stock split. Before and after, its prospects remain very fuzzy. Williams-Sonoma’s? Not so much.

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