Most Shorted Stocks #10 – GameStop

By Chad Henage - March 6, 2012 | Tickers: AMZN, GME | 0 Comments

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I recently read an article that outlined the most shorted stocks in the market, based on percentage of shares sold short. Stocks that are shorted always fascinate me, because without leverage, the total percent that can be gained is 100%. In the traditional long trade, there is no limit to how much you can make. I guess by nature I root for the underdog, so I wanted to see if any of these most shorted stocks might represent a buying opportunity. Stocks with a heavy short interest can be volatile, but if the shorts are wrong you can see big gains in a short (pun intended) amount of time. The company ranked #10 most shorted stock by percentage of shares, is GameStop (NYSE: GME) with 32% short interest.

I know the reasons that most shorts would give for GameStop's potential demise. Most would say this is a traditional brick and mortar retailer, and they can't compete against digital content. Shorts would also say, that online retailers can sell games for cheaper. I won't rehash everything I've already said about GameStop in my prior blog. If you want to read the reasons I think shorts are on the wrong end of this trade click here. In summary though, I will say that GameStop is cash flow positive, has a newly minted dividend, and appears slightly undervalued. The company has not missed earnings in the last 4 quarters, and actually beat estimates in 2 quarters. Further, they show no long term debt, and over $440 million in cash on their balance sheet. Below is what the current numbers look like as of today:

Current Price: $23.81
P/E on '12 earnings: 7.51
Growth expected: 8.10%
PEG: 0.93
Yield: 2.52%

So what else is going on with GameStop that the shorts might not be appreciating? First, let's take the argument that GameStop is a traditional retailer and can't compete against digital content. I would begin by asking do you know about Kongregate? This is GameStop's online portal where at the time I'm writing this, there are over 50,000 people playing online games. I realize this isn't millions like other sites, but it certainly shows that GameStop isn't blind to the idea of digital gaming. Second, a prominent feature of the web site is PC Downloads. This part of the site, shows over 100 publishers offering games available for instant download. We aren't talking old games either, there are downloads for Call of Duty Modern Warfare, Battlefield 3, and Assassin's Creed. Those are household names in the gaming industry.

Second, most shorts would say, GameStop can't compete on pricing with companies like Amazon.com (NASDAQ: AMZN). Let's test that theory for a minute. I'll pick a few items, and we'll see whether Amazon is pricing GameStop out of business.

So three different items, three different systems, and as you can see GameStop is price competitive in all three cases. I would also make the argument, that as console games are not cheap, quality of pre-owned games is a important factor in the industry. If you want a reputable place to buy pre-owned games, there isn't a better destination than GameStop. GameStop's well known trade-in deals, allow the company to gain inventory, at prices the company knows it can make a profit on. This gives GameStop an advantage that online retailers will never have. After all, if a gamer can walk into GameStop, and get credit immediately towards a purchase at the store, why would they ship that same game to Amazon to trade it in?

I just don't see shorting this stock. They may not grow at over 12% as they have in the past few years. However, if the company grows earnings at 8%, and pays a 2.5% dividend you are still looking at an expected return of 10.5%. I've already placed my green thumbs-up on GME on CAPSCall and I see no reason to change that position. Let me know what you think in the comments section below.

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