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As the Gamestop share price craters, should I buy?

Last week was a painful one for investors in Gamestop (NYSE: GME). The Gamestop share price fell 19% in just one week, based on Friday’s closing price on the New York market. It’s still up over 1,100% in the past year, admittedly. But I don’t think last year’s share price crash presents me with a buying opportunity for my portfolio. Here are three reasons why.

1. Yesterday’s business in tomorrow’s world

Back in the 1980s and early 1990s, there was a massive business called Blockbuster. In the UK, like the US, it was present in towns and cities across the land. Over time, though, demand for renting video cassettes plummeted. Blockbuster tried to update its business model but it was too little, too late.

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Gamestop has been facing similar market dynamics in some ways. Its core business of selling physical computer games has come under pressure as more game sales take place online. That doesn’t mean the business is finished. A lot of gamers still like to buy physical games in a shop. Gamestop has beefed up its business model with ancillary revenue streams. Nonetheless, the business risks becoming outdated. That could lead to revenues falling,  as happened last year.

I think Gamestop could use its large presence, customer loyalty, and gaming expertise to turn its physical store estate into an asset with enduring relevance. But there’s no guarantee that approach will work.

2. Heady valuation

Gamestop shares have been caught in a speculative frenzy this year. As an investor not a speculator, that always concerns me.

It’s been good and bad news for Gamestop in my view. A higher share price has enabled Gamestop to raise cash by issuing shares. However, it also means the Gamestop share price is now out of step with the company’s value, in my view. Currently, the Gamestop market capitalisation is around $15bn. For a loss-making company in an industry with an uncertain future, that seems expensive to me. Even if I thought the fundamentals of the Gamestop business were attractive – and I don’t – I’d still be hesitant to buy shares at such a high price.

3. The Gamestop share price and wild sentiment

Many share prices reflect the tension between a company’s business fundamentals and how investors feel about its shares. The latter phenomenon, sentiment, can be a powerful force.

As we’ve seen over the past year, the Gamestop share price has been on a wild ride largely disconnected from its business performance. That’s because its shares have seen a speculative frenzy. While that has died down from its heights, Gamestop remains popular with many speculators. As last week showed, it is still subject to dramatic price swings.

Speculation can keep a share price detached from the business fundamentals for months or even years. Not only can it keep a share price improbably high – it can also  punish a good company by consistently leading to it being undervalued. Right now, not only do I think the Gamestop share price is overvalued, I’m also concerned that ongoing speculation could sustain an imbalance between its worth and cost. That is a risk for an investor like me. Despite its share price fall last week, I won’t be buying Gamestop for my portfolio.

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Christopher Ruane has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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