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The Worst Isn't Over for GameStop: Here's Why

The echo chamber is a bad place to be if you're an investor. Bulls who only see the positives are toast. Bears who only see the negatives are toast. Shares of GameStop (NYSE: GME) have been whipsawed these days, and with every move up or down, you're seeing the camp with the tailwind trying to slam-dunk on the other, and that's a big mistake.

There's real money being made (and more importantly, lost) here. Investing isn't a video game. The narrative is also changing rapidly. If you think you know the players on either side of this first-person shooter, you may want to pull up the lineup card that's been scribbled over countless times as the game plays out.

More than 871 million shares have been traded in the last eight trading days for a stock with less than 70 million shares outstanding. The greedy hedge funds that were short the stock were squeezed out in January. The early "hold the line" cheerleaders have probably dropped the line by now, high-fiving one another all the way to the bank.

The longs are new. The shorts are new. At one point, GameStop is going to be valued as a business instead of a battle cry. When that reality comes, the stock will probably be a lot lower than it is right now.

There's no joy in this stick

There are frames of reference that can make any side look good. A stock that traded as high as $483 on Wednesday of last week closed at $90 on Tuesday of this week. Bears are killing it! However, this is also a stock that kicked off 2021 in the high teens. And that was after more than tripling in 2020. Bulls are killing it!

The dynamics that have made GameStop a bottle rocket are real, but so are the reasons it's been fizzling out in recent days. There was a lot of short interest in the stock, and with a float as shallow as a kiddie pool, it was easy for a large group of speculators to send the boo birds scrambling for the exits.

The short-squeeze game will be harder to play now. Some third-party reports out of IHS Markit and S3 Partners have the number of shorts right now at roughly a third of what they were in mid January. With a market cap well above $30 billion at last week's peak, it's also going to be harder to gather up enough joyriders with the means to drive the shares higher even through speculative options play.

What is GameStop worth? The answer is personal in the near term, but a little clearer in the long run. Over the past year, the stock has been worth as little as $72 million and as much as $33.7 billion based on market cap. That's wild, unusual, and ultimately deceptive.

GameStop is a shrinking business; the numbers bear that out. Sales are a little more than half of what they were eight years ago, and the fade-out is accelerating. GameStop has seen sharp double-digit declines in sales in back-to-back fiscal years. The "Uncle!" is heard loud and clear. There are 11% fewer stores open now than a year ago. The business model used to be the envy of the strip mall, but now GameStop's not even generating positive operating income. This is a deteriorating business.

You would think that a company devoted to video games would be all up on game theory, and that's fair. GameStop saw the demise coming. It diversified into physical goods like collectibles and playthings when gaming went digital. It made a couple of acquisitions in digital delivery and even a smart deal last year to cash in on downstream revenue in the digital revolution. The numbers tell you how badly that has all played out.

GameStop isn't going away overnight, but the time is running out on its reinvention. It's not going to keep going straight down. There will be breaks. There will be rallies. There will be shake-outs of the next wave of shorts. Betting on or against GameStop will continue to be risky, but the long-term trajectory of the business is bleak for believers.

Don't buy GameStop with money that you will need. Don't short GameStop with money that you will need. The balance of the market is still out there, and it will make a lot more sense.

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