At a glance, GameStop (GME) is a tempting dividend stock for retired income investors.
GameStop offers a high dividend yield in excess of 6% and has increased its dividend every year since initiating its dividend program in 2012.
The company has a healthy payout ratio near 40% and consistently generates positive free cash flow as well.
But at the same time, it’s important to note that high yields, especially in this time of historically low interest rates, can be a red flag that a company is a “value trap,” meaning that something is deeply flawed about its business model.
Let’s take a look at GameStop’s high yield using our Dividend Safety Scores to see if the company could be worth owning in a diversified dividend growth portfolio.
Business Overview
Founded in 1994 in Grapevine, Texas, GameStop operates more than 7,600 stores in the U.S., Australia, Canada, and Europe.
Its primary business is selling new and used video game hardware and software, including accessories such as gaming consoles, controllers, gaming headsets, and memory cards. These segments account for more than 65% of GameStop’s gross profit.
Source: GameStop Investor Presentation
In recent years, GameStop attempted to diversify its business by getting into the consumer electronics business, specifically selling new and used smartphones and tablets, as well as launching Spring Mobile.
Spring Mobile is an AT&T (T) authorized reseller that sells pre-paid phone plans under the Cricket Wireless brand. The company has also partnered with Apple (AAPL) to launch 72 Simply Mac specialty stores, which serve as tech support hubs for Apple products.
GameStop also owns a diverse portfolio of video game websites such as Ebgames.com, Kongragate.com, and Thinkgeek.com.
While 2016 saw non-physical gaming revenues of over $2 billion, at the end of the day GameStop continues to be a company whose fortunes remain tied to physical gaming hardware, which is an industry in secular decline.
Even management’s long-term plan to continue diversifying its sales, earnings, and cash flow, won’t change that anytime soon. Physical video games are still expected to account for about 50% of earnings in 2019.
Business Analysis
As you can see, GameStop has had a problem in recent years with slowing sales and earnings growth.
Source: Simply Safe Dividends
Source: Simply Safe Dividends
Worse yet, the small amount of earnings per share and free cash flow per share growth has mainly been a result of the company buying back shares at an impressive rate of 6.6% per year over the last seven years.
When shares outstanding decrease, net income and free cash flow is higher on a per share basis even if their total dollar amounts haven’t changed. This game can only last so long if a business is unable to actually grow its bottom line.
Source: Simply Safe Dividends
In recent quarters, GameStop’s financial engineering efforts have started to flounder, with sales declines resulting in deterioration in both profit margins and earnings per share.
Source: Simply Safe Dividends
Source: Simply Safe Dividends
The problem is that GameStop’s core business of selling gaming hardware and physical video games is coming under pressure from the likes of Sony and Microsoft (MSFT).
Specifically, the video game industry is evolving away from physical games and towards digital downloads.
For example, Playstation and Xbox are increasingly moving towards a subscription based business.
Rather than owning hard copies of the games played on their consoles (and that can be sold to GameStop for resale to other gamers at a profit), Sony and Microsoft are monetizing their gaming businesses at GameStop’s expense by renting out the games via online channels.
The need for a brick-and-mortar retailer is increasingly diminished by e-commerce yet again, and this isn’t just limited to new games either.
For example, Microsoft just announced Game Pass, a $9.99 per month subscription service that gives subscribers access to over 100 of the most popular older Xbox One and Xbox 360 games.
Worse yet? Subscribers will be able to purchase these games at a 20% discount to their retail price, news that directly impacts GameStop’s bottom line (GameStop generates over 30% of its gross profit from older game sales).
