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Tuesday, January 21, 2014 - 08:30
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Tuesday, January 21, 2014 - 08:30

This Misunderstood Stock Could Gain 40%

Tuesday, January 21, 2014 8:30 AM

The size and reach of this relatively new industry is astounding. Once written off as just a passing fad for children and teenagers, this sector has become a major economic force -- and its growth shows no signs of abating.

Consumers spent nearly $21 billion in this sector in 2012, and nearly 60% of Americans actively participate in this form of entertainment. I can't think of another hobby or sport that involves so many participants.

Although this business is widely thought of as being a pastime for teenagers, the average age of its participants is 30 years old, and 45% of them are female. If you haven't already guessed, this huge and thriving industry is electronic gaming.

Electronic gaming has grown from the video game parlors of yesterday to a multi-billion-dollar industry that touches an enormous segment of the population. There are plenty of profit opportunities across the industry for savvy investors, but I want to focus on a particular company that's well positioned to earn long-term profits from the electronic gaming revolution.

The company is GameStop (NYSE: GME), the world's largest multi-channel video game retailer. In addition to nearly 6,500 stores in 15 countries, GameStop owns Kongregate.com, a browser-based game site; Spawn Labs, a streaming technology company; a magazine dedicated to electronic gaming; and a digital PC game distribution platform.

Flickr/Moe_
GameStop owns nearly 6,500 stores in 15 countries.

Boasting a market cap of $4.3 billion, GameStop posted revenue of $8.9 billion and gross profit of $2.7 billion in its most recent fiscal year. The company had a strong third quarter, with a 20.5% increase in comparable-store sales and a 45% increase in adjusted net income.

Despite these impressive numbers, the company issued a warning for the current fourth quarter. It said to expect video game sales to be down 22% from the year-ago quarter. In addition, GameStop has forecast earnings between $1.85 and $1.95, which is lower than the average analyst estimate of $2.14.

This bad news sent shares plunging, but I think this is simply a short-term overreaction -- which opens up a great buying opportunity for long-term investors. Remember, shares have almost doubled since last year and are still higher by over 50%.

Although the company boasts a solid annual trailing dividend yield of 2.9%, the real story is GameStop's share repurchase programs.

As you know, share buybacks are simply another way companies enrich their investors. My colleague Nathan Slaughter is a huge fan of companies with substantial stock buyback programs, which hey often says are indicative of management's confidence in their own company. That's not to mention the obvious benefits to shareholders, who often see the value of their shares climb as a result.

Gamestop bought back $76.8 million of its shares in the third quarter and authorized another $500 million in buybacks, which is in addition to $240 million remaining from previous authorizations.

A look at the technical picture shows GME has plunged below the support line of the 200-day simple moving average to find support at $36. The price has since bounced directly below the $38 level where a breakout entry point has formed.

Risks to Consider: Although GameStop is well positioned to capture its share of the growing video game market, there is always the danger of another form of entertainment taking market share. Like all things technologically based, change is a given. The only question is how long will the trend continue. Remember to always use stop-loss orders and diversify properly when investing.

Action to Take --> I like that GameStop is positioned as the world's largest retailer of electronic games. GameStop's fortunes rest with the entire gaming industry, not any particular type or genre of game, which gives the company the flexibility to easily adapt to an ever-changing gaming culture. In addition, the aggressive buyback programs lift my confidence in the long-term viability of the shares. Buying GME when it posts a breakout close above $38 makes solid investing sense. My 12-month target price is $52, which represents nearly 40% upside from current levels.

P.S. As much as I like Gamestop for its stock buybacks, that's only part of the picture. In fact, our latest research indicates that stock buybacks are just one ingredient to a formula we call "Total Yield" that beats the market hands-down. My colleague Nathan Slaughter has put together a free step-by-step guide that tells you everything you need to know, which you can access by clicking here.

David Goodboy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.