Financial Literacy Reveals The Sad Truth About The GameStop Stock Surge

Financial Literacy Reveals The Sad Truth About The GameStop Stock Surge

At first, I had to grin as I learned about the David versus Goliath saga related to GameStop that unfolded last week, but unfortunately my financial literacy tells me that this story will end as a tragedy.

Last week my son called out from his room, “Hey Dad, what is going on with the stock market?”

I had no idea but given our current turbulent times, this vague comment was a little alarming for me. I quickly made my way down the hall to clarify the question.

“What do you mean?  Why do you ask?  What is going on?” I rapidly shot my questions at him without waiting for a response. (This is something that as a coach, I am trained not to do but sometimes we just react to certain situations without thinking).

He said that a buddy of his posted on social media that he made $7,000 overnight from his stock portfolio. 

This was interesting to me on many levels.  First, I was surprised that one of his buddies had a stock portfolio at the age of 18.  On top of that, earning $7,000 overnight seemed unbelievable, but before asking more details about this buddy, I decided to spin around and call back to him, “Let’s check it out and see what we see on the news!”

In just a matter of minutes, we saw the scroll of the news program reveal the answer.  The stock of GameStop (GME) had shot up in value to $347.51 per share at the close of January 27th from $147.98 per share the prior day.  It had been trading around only $18 per share just 3 weeks earlier!  The story behind the surge of the stock price was presented as a David versus Goliath tale with main street taking it to wall street for a change.  I could not help but grin as I continued to listen to the commentators.

Some bloggers on Reddit had successfully encouraged individual “main street” investors to ban together to save the struggling company, GameStop, while also inflicting some damage to greedy wall street hedge funds who were currently “shorting” the stock and betting on the company’s demise.

How could you not cheer and grin as main street taught wall street a lesson, punishing the evil hedge funds who were betting against our beloved GameStop, (My son and I had frequented our own local GameStop regularly during his “gamer” days before he became an athlete) but who are we kidding? 

I explained to my son that despite this being a satisfying political statement, it is inevitable that these same righteous amateur investors will end up taking the biggest losses in the long run. 

My son responded, “That is a bummer, why do you say that and how do you know?”

I replied, “You know that as a professor, I teach my students how to read financial statements, right?”

“Yeah”.

“Well, I happen to know that GameStop, like many brick and mortar retail stores, has been on a downward trajectory for years, even before the pandemic.  Consumers are buying more things online.  An artificial surge that is not backed up by financial performance does not add real value and is just not sustainable in the long run.  As a result, someone is going to take losses in this scenario.  Wall Street understands the financial fundamentals of GameStop but most of these amateur investors are just that, amateurs who do not understand financial statements, financial trends and ratios. They lack financial literacy.  Most likely it will be the individual investors who take the biggest hit as the stock price of GameStop falls back to a more accurate valuation based upon financial fundamentals.”

That was a lot for my son to take in, but he is a bright kid.  He said, “We are talking about GameStop but Jake (we will name his buddy “Jake” to avoid his real name) said that his whole stock portfolio increased last night.”

I replied, “My guess is that Jake has invested fairly heavily in GameStop.  By the way, how did Jake get a stock portfolio?  Did he inherit some money or get some from his parents?”

“Oh, no. Jake is always working to make money.  He sells old cell phones and stuff on FaceBook marketplace.  Once he started to make some money, he began to invest in stocks through Robinhood where you can purchase small amounts of individual stock without paying any commission.”

“Wow.  Jake is a real go-getter”

“Yeah.”

“He told you all of that stuff about Robinhood and investing?”

“Yeah. He is kind of trying to share what he learns along the way.  I was thinking maybe I should invest some of my money that I get from working at the gym.”

“I am impressed that you guys are talking about these types of things.  If you are interested in making some long-term investments with your gym money, we should get a Roth IRA set up for you because that will really pay off for you down the road if you leave the money in there to grow.”

“Whatever you say, Dad, but I have to get back to my homework. I will ask Jake if he did invest in GameStop.”

“OK.  If he did invest in GameStop, that explains what is going on with his portfolio but you might want to tell him to sell GameStop today if he can because that stock value will not last.”

My son replied “OK”, then turned back to his room to finish his homework and endure through some more zoom meetings.

I decided to run some numbers on GameStop to see what the financial statements were telling me and now I was also interested in the brokerage, Robinhood. 

First, I did some research on Robinhood.  The news had mentioned that Robinhood was a driving force behind the individual investors who ignited the GameStop stock surge.  I was wondering how a brokerage that did not charge commissions actually made money.

The name of the company conjures up images of robbing from the rich to feed the poor but Robinhood, the brokerage, is far from the Robin Hood of fairy tales.  The name would suggest that the brokerage champions the little guy but unfortunately the Robinhood brokerage earns the bulk of its revenues by taking advantage of the lack of financial literacy of the uninformed amateur investor while enriching wall street hedge funds that back the brokerage. The scenario is one that is similar to a casino where the house always wins. 

Analysis of the financial information for GameStop revealed the following:

Probably the most concerning trend is the negative net sales trend from year to year over the past few years which has also influenced increased losses and negative cash flows.  Between FY 2018 and FY 2019 net sales dropped 22.0%.  For the first 3 quarters of 2020, net sales are down another 30.5% when compared to the prior year.  In addition to decreased revenues, the gross profit margin has dropped slightly to 27.3% for the 3 quarters of 2020 compared to a gross profit margin of 29.5% for FY 2019.  For the 3 quarters ending 10/31/20, the operating profit margin is -8.6% and the net profit margin is -10.0% so the company continues to lose money despite selling off unprofitable assets.  The loss for the 3 quarters of 2020 equates to -4.56 earnings per share with 64.9 million weighted shares outstanding.  FY 2019 resulted in a 470.9 million loss for the company to follow up the 673.0 million loss for the company in FY 2018.  This equates to -5.38 earnings per share for FY 2019 and -6.59 EPS for FY 2018.  The company continues to bleed cash with 41.1 million in cash outflows from operating activities for the 3 quarters of 2020 which followed cash outflows from operating activities of 414.5 million in FY 2019.  The company had negative Free Operating Cash Flow of 493 million and negative Free Cash Flows of 475.4 million in FY 2019.  Goodwill impairments significantly reduced earnings over the past two years as the value for the brand continues to take a beating.  Assets were reduced 30.3% from 2018 to 2019 while the percentage of debt increased for the company.  The debt ratio increased from .38 in 2018 to .66 in 2019.  In my opinion, the financials tell me that GameStop is a sinking ship with a tremendously negative sales trend that is sucking the company under.  Only a radical change in the company’s business model will save it from becoming the next Blockbuster Video.

If the past paragraph seems like a foreign language to you and you would like to add financial literacy to your skillset so that you might have a chance to “beat the house”, I can help.  I offer an 8-week intensive course to teach students how to read and interpret the annual reports of companies like GameStop.  The course is called “Financial Literacy:  The Language of Business” and it is currently being held in Zoom format with room for 8 to 16 students per class.  Please send me an e-mail to jay@jayvarcoe.com or a message in Linked In if you are interested in learning more about the course and when the next one will start.

You may be wondering what happened to Jake and his portfolio.  It turns out that my son did not get in touch with Jake last week but he checked in with him yesterday.  Jake did have shares of GameStop which had inflated his stock portfolio on that day last week.  I was sad to hear that Jake had continued to invest in GameStop as the stock value increased.  He told my son that he ended up taking a loss due to the dropping values of GameStop over the past few days.  The stock closed yesterday at 53.50 per share but he said not to worry because he is currently making a killing on Bitcoin!