Is GameStop Stock Finally Turning the Corner?

One of the more interesting stocks reporting fresh financial results this week is GameStop (NYSE: GME). The video game retailer and OG of meme stocks will step up with its fiscal third-quarter report after the market close on Tuesday.

GameStop has struggled with growth in recent years. Net sales declined for six of the last seven fiscal years. Even the one year of positive top-line growth -- fiscal 2021 -- followed the pandemic-hobbled fiscal 2020. Fiscal 2021's net sales were still 7% below where GameStop landed two years ago.

The downticks add up over time. GameStop's net sales are a brutal 59% below their peak in 2015. Will the upticks add up over time now? The chain came through with a 22% year-over-year jump for its fiscal second quarter, ended Aug. 2. Analysts see double-digit gains in net sales through the second half of this year. Profitability is growing even faster. Is the video game stocks bellwether ready to be appreciated by more than just its cult base of investors? Let's take a closer look at GameStop in a week in which the retailer has a lot to prove to start winning again.

Image source: Getty Images.

Relishing the respawning process

Expectations are high as we head into Tuesday afternoon's financial update, admittedly coming from limited analyst coverage. GameStop is expected to deliver $987.4 million in net sales for its fiscal third quarter, representing a 15% step up from where it was a year earlier. Analysts are modeling a similar increase for the new holiday quarter, which ends in early February.

There is a point worth making about the 22%, 15%, and 15% growth that the market is modeling for the final three quarters of fiscal 2025. They follow declines of 29%, 31%, and 20% in the last three fiscal 2024 reports, respectively. In other words, we're back to the argument that even a positive net sales breakthrough is still lower than it was two years ago.

The bottom line is the better story for the retail stock. Analysts are targeting a profit of $0.20 a share for this week's quarterly update, more than tripling its net income of $0.06 a share a year earlier. It gets better. GameStop has consistently delivered quarterly bottom-line beats of 61% or better over the past year. This will be the third consecutive year that GameStop has been profitable, a feat that the market hasn't seen from the small-box retailer since fiscal 2017. It should also be back-to-back years of profitable earnings growth, something that GameStop hasn't done since fiscal 2015.

Learning to play a new game

A look back at the fiscal second quarter that GameStop reported in September reveals how the business model has evolved dramatically over the years. Hardware sales rose 31%, fueled largely by the June launch of Nintendo's Switch 2 console. Collectibles is now the second largest category at GameStop, soaring 63% in the second quarter.

Software -- the high-margin bread-and-butter segment that fueled the chain's growth for decades -- plummeted 27% for the quarter, making up less than 16% of the revenue mix. Software continues to be the lifeblood of the gaming industry, but with digital delivery and game streaming services exploding in popularity, it has come at the expense of physical discs and cartridges.

Software has always been a higher-margin business for GameStop than hardware, and its resale business has commanded even larger markups. Video game console makers and software publishers reaching players directly have upended that market. Collectibles have helped fill that void, but can this category be differentiated enough for GameStop to stand out in this market?

The good news is that the financials are making it up in sales volume right now. Gross margin may have contracted year over year in the fiscal second quarter, but the bottom line itself continues to widen. GameStop is trading at a reasonable P/E ratio of 23 for this fiscal year's projected earnings. The long-term outlook remains fuzzy, but a positive reversal in fundamentals is still worth celebrating in the near term.

Rick Munarriz has positions in Nintendo. The Motley Fool recommends Nintendo. The Motley Fool has a disclosure policy.