# GameStop Corp (GME) Trading at Fair Value

November 22nd, 2012 Posted by criseldar Investment Valuation No Comment yetGameStop Corp (GME) is an American video game, consumer electronics, and wireless services, retailer. The company is headquartered in Grapevine, Texas, United States, a suburb of Dallas, and operates 7,267 retail stores throughout the United States, Canada, Australia, New Zealand, and Europe. Wikipedia.

**GameStop Value Investing Approach**

This model is prepared in a very simple and easy way to value a company, it adopts the investment style of the Father of Value Investing Benjamin Graham. The essence is that any investment should be purchased at a discount, meaning the true value should be more than the market value. Further, Graham believed in fundamental analysis and was looking for companies with a sound balance sheet and with little debt. The basis for this valuation is the company’s five years of historical financial records, the balance sheet, income statement, and cash flow statement. We calculated first the enterprise value as our first step. We believed this is important because it measures the total value of the company.

**The Investment in Enterprise Value**

The concept of enterprise value is to calculate what it would cost to purchase an entire business. Enterprise Value EV) is the present value of the entire company. Market capitalization is the total value of the company’s equity shares. In essence, it is a company’s theoretical takeover price, because the buyer would have to buy all of the stock and pay off existing debt, and taking any remaining cash.

*Enterprise Value = Market Capitalization + Total Debt – (Cash and Cash Equivalent + Short Term Investment)*

#### Explanation

The table shows that the market capitalization of GameStop Corp deteriorated at 65 percent in 2008 and 5 percent average thereafter. The total debt was represented 7.3 percent, while the cash and cash equivalent was 15 percent. Therefore, the enterprise value was lower by 8 percent against market value. Purchasing the entire business is buying 100 of its equity, no payoff for existing debt since cash and cash equivalent was greater than the total debt.

Buying the entire business of GameStop the investor would be paying $2.9 billion at $21.32 per share. The current market price to date, November 6, 2012, is $23.72 per share.

**Net Current Asset Value (NCAV) Method **

The concept of this method is to identify stocks trading at a discount to the company’s Net Current Asset Value per Share, specifically two-thirds or 66 percent of net current asset value.

GameStop tells us that the stock was trading at an overvalued price because the market value was greater than the 66 percent of NCAV.

It indicates that the stock was trading above the liquidation value of GameStop, therefore, the price was expensive.

**Market Capitalization/Net Current Asset Value (MC/NCAV) Valuation **

Another stock test is by using market capitalization and dividing it to net current asset value (NCAV). If the result does not exceed the ratio of 1.2, then the stock passes the test for buying. So, let us see if the stock of GameStop passes the stock test.

The MC/NCAV valuation indicates that the price was overvalued from 2007 to ttm9 2012 because the ratio exceeded the 1.2 ratios. Therefore, the price was expensive. The stock of GameStop indicates that it did not pass the test.

**The margin of Safety (MOS) **

The margin of safety is used to identify the difference between company value and price. Value investing is based on the assumption that two values are attached to all companies, the market price and the company’s business value or true value. Graham called it the intrinsic value. The difference between the two values is called the margin of safety. According to Graham, the investor should invest only if the market price is trading at a discount to its intrinsic value. Value investing is buying with a sufficient margin of safety. Moreover, Graham considers buying when the market price is considerably lower than the intrinsic or real value, a minimum of 40 to 50 percent below. The enterprise value is used because, in my opinion, it is a much more accurate measure of the company’s true market value than market capitalization.

#### Explanation

The margin of safety valuation tells us that there was a margin of safety for GameStop from 2007 to ttm9 2012 at an average of 69 percent. The highest MOS was in 2008 at 82 percent.

The intrinsic value for GME was erratic in movement and the average intrinsic value was $89.

*Intrinsic Value = Current Earnings x (9 + 2 x Sustainable Growth Rate) *

The most important factor for intrinsic value was the sustainable growth rate and the earnings per share. The earning per share is a good measure of profitability, and it represents the earning power of the company. The formula for Earning Per Share (EPS) was:

#### Sustainable Growth Rate (SGR)

The average ROE of GameStop Corp was 14.85 percent while the average SGR was 14.6. There was no payout ratio from 2007 to 2011 because the company is not paying any cash dividend. In the trailing twelve months, there was a payout ratio of 12.6.

The intrinsic value line was higher than the enterprise value line, meaning, there was a margin of safety for GameStop from 2007 to ttm9 2012. The space between these two lines is the margin of safety. Calculating the space in figures, it will give us a 69 percent average, as shown in the table above.

#### Relative and Average Approaches

There are two approaches in calculating the sustainable growth rate, and that is, by using the relative return on equity ratio and the average ROE. I have summarized the results of using these two approaches in the table below.

The table shows that by using the average approach in calculating the sustainable growth rate produces a lower percentage of a margin of safety.

**Price to Earnings/Earning Per Share (P/E*EPS)**

This method will determine whether the stocks are undervalued or overvalued by multiplying the Price to Earnings (P/E) ratio with the company’s relative Earning per Share (EPS) and comparing it to the enterprise value per share, we can determine the status of the stock price.

The P/E*EPS was $32 while the enterprise value per share was $26. The ratio was 22 percent below the enterprise value per share. It indicates that the price of GameStop Corp was cheap using the PE/*EPS.

The two approaches in calculating this valuation are by using the relative and the average price to earnings ratio. The table below summarizes the results of these two approaches.

Using the average price to earnings ratio, the data conveys us a high result, thus it is more favorable than by using the relative ratio.

**Enterprise Value (EV)/Earning Per Share (EPS) or (EV/EPS) **

The use of this ratio is to separate price and earnings in enterprise value. By dividing the enterprise value to projected earnings (EPS), the result represents the price (P/E) and the difference represents the earnings (EPS).

The EV/EPS valuation tells us that the price (P/E) was 47 percent and the earnings (EPS) was 53 percent average. This means that, out of the enterprise value per share, the price was nearly half and earnings were a little more than half. This is the price that the investor is willing to pay.

This might indicate that the stock of GME was trading at fair value.

**Enterprise Value (EV)/ Earnings Before Interest, Tax, Depreciation, and Amortization (EBITDA) or (EV/EBITDA). **

This metric is used in estimating business valuation. It compares the value of the company inclusive of debt and other liabilities to the actual cash earnings exclusive of non-cash expenses.

The EV/EBITDA valuation tells us that it will take an average of 6 years to cover the costs of buying the entire business. In other words, it will take 6 times the cash earnings to cover the costs of purchasing.

This metric is also used to gauge the profitability of the company. Digging into the financials of GameStop, it shows that the net earnings were 4 percent average. The company had a free cash flow of 2007 to ttm9 2012.

**In conclusion,**

The market capitalization for GameStop was deteriorating at a rate of 641 percent. Its total debt was 7.3 percent and its cash and cash equivalent was 15 percent. Thus the enterprise value was lesser of 8 percent than the market value. Purchasing the entire business to date, November 6, 2012, will cost $2.9 billion at $21.32 per share. Today’s market price was $23.72 per share.

The net current asset value method, tells us that the price was overvalued because the market value was greater than the 66 percent of NCAV ratio. Thus indicating that the price was expensive. On the other hand, MC/NCAV method shows that the price was overvalued because the ratio exceeded the 1.2 ratios. Thus indicating the price was expensive, therefore, the stock of GameStop has not passed the stock test.

#### The margin of safety

Moreover, the margin of safety on GameStop was averaging 69 percent. The sustainable growth rate was $14.62 while the annual growth rate was $38.23. On the other hand, the return on equity was 14.85 percent while the earnings per share were $2 average.

The price was undervalued because the enterprise value was lesser by 22 percent against the P/E*EPS ratio. While the EV/EPS tells us that the price (P/E) was a 47 percent and the earnings (EPS) was 53 percent.

#### Relative valuation

The EV/EBITDA valuation indicates that it will take 6 years to cover the costs of purchasing the business. In other words, it will take 6 times the cash earnings to cover the costs of buying GameStop.

Overall, the stock of GME was trading at a price that was fair value. Therefore, I recommend a **HOLD** on the stock of GameStop Corp.

Research and Written by Cris