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Is Game Digital plc a falling knife to catch after dropping 30% today?

The release of a profit warning is never welcomed by investors. Friday saw video game retailer Game Digital (LSE: GMD) release a downgrade to guidance for the full year. This has caused its shares to decline by 30%, which shows just how negative investor sentiment has become. In the short run, more share price falls could be ahead, but could there be value in the retailer for long-term investors?

A difficult trading environment

As highlighted in the company’s half-year results in March, the challenging trading environment in the UK continues to make life difficult for retailers. However, Game Digital had been upbeat about its prospects in the second half of the year. This was based on the release of the latest console from Nintendo. This was expected to cause a spike in sales and while that has happened, the extent of the increase in sales has been lower than anticipated due to lower than forecast supply of the console.

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Although the company continues to anticipate positive gross transaction value growth in the second half of the year of approximately 5%-6%, this is down on its previous expectations. This is also partly due to a soft overall video games market, with consumer spending on discretionary items likely to come under further pressure. The main reason for this is higher inflation which is now ahead of wage growth. This means consumers have less disposable income in real terms to spend on items such as consoles and video games.

Outlook

The prospects for retailers such as Game Digital and Games Workshop (LSE: GAW) appear to be rather bleak. The outlook for consumer spending remains tough and, realistically, things could get worse before they get better. Political risk remains high, and this could hurt business confidence and create a prolonged period of economic gloom. This may lead to profit warnings across the retail sector such as that experienced by Game Digital on Friday.

In terms of the future prospects for the firm, it seems to be dependent upon the supply levels of the latest Nintendo console. While it is optimistic about this, there is no guarantee that supply levels will improve. Therefore, it may be prudent for investors to await further updates before buying a slice of the business, given its uncertain outlook.

In the case of Games Workshop, it is forecast to deliver a fall in earnings of 11% this year. This is due to be followed with growth of 3% next year. Given that it trades on a price-to-earnings (P/E) ratio of 14.6, it seems to lack a sufficiently wide margin of safety to warrant investment at the present time. While the company may have a sound strategy and strong business model, external factors could count against it and lead to relatively disappointing share price performance.

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Peter Stephens has no position in any 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.