GameStop’s soaring market value has it big enough to enter the S&P 500 - but the company faces still faces other hurdles before it can be included

]

While some stock indices follow systematic criteria, which names get included in the S&P 500 is set by a committee of anonymous staffers at S&P Dow Jones Indices.

GameStop, which was S&P 500-listed as recently as 2016, now once again meets a number of S&P’s rules.

But GameStop’s biggest hurdle to index inclusion could be its lack of profitability.

Sign up here for our daily newsletter, 10 Things Before the Opening Bell.

GameStop’s stunning run up in 2021 has given the company a market value that more than exceeds the threshold for S&P 500 inclusion. But it still faces significant hurdles, due largely to a handful of factors outlined in a new Wall Street Journal report.

While some stock indices follow systematic criteria, which stocks get included in the S&P 500 is set by a committee of anonymous staffers at S&P Dow Jones Indices. The committee leans on a number of rules but has ultimate discretion over the process.

GameStop, which was S&P 500-listed as recently as 2016, now once again meets a number of S&P’s rules. The stock’s market capitalization, currently around $16 billion, is well above the required floor of $13.1 billion. GameStop shares are also highly liquid and held largely by the public.

But GameStop’s biggest hurdle to index inclusion could be its lack of sustained profitability. S&P rules say listed companies must have positive earnings in both the most recent quarter and the past year. The game retailer, however, generated a loss in the first quarter of 2021 as well as three of four quarters in 2020.

In principle, the S&P committee could look past GameStop’s soft earnings for one reason or another - perhaps on account of its towering market value. But given the speed of GameStop’s rise, the committee could be nervous about approving its inclusion too soon, Art Hogan, chief market strategist at National Securities Corporation, told the Journal.

“While the company may check most of the boxes, it is hard to know how long that will be the case,” he said.

The S&P committee has also seemed to downplay raw market cap in certain cases. Several of the S&P 500’s smallest players have markets caps well below the supposed minimum, such as NOV Inc.’s $5 billion market valuation.

“Entrance to the S&P 500 is a combination of both art and science,” Hogan told the Journal.

Possibility of Return of GameStop Stock to S & P500 by Anonymous Committee

]

GameStop Corp, the beloved individual investor. Is currently worth three times the smallest S & P 500 share, thanks to the stock price surge in August.

Some traders are betting that GameStop could take a leap forward if it adds shares to the S & P 500 when the S & P Dow Jones Index is rebalanced later this year.

Acquiring shares in the most widely monitored indexes is not an easy and predictable process. The S & P 500 is built by a human committee, unlike the index, which includes the Russell 2000, whose composition is primarily determined by criteria such as market capitalization. The identities of committee members who are full-time staff members of the S & P Dow Jones Index remain anonymous.

“Entering the S & P 500 is a combination of both art and science,” said Art Hogan, Chief Market Strategist at National Securities Corp.

Committee members have some rules to follow when deciding to make changes to the S & P 500. The company added to the index must be, for example, a liquid US company with a market capitalization of at least $ 13.1 billion. In addition, the committee can afford to make changes.

GameStop Q2 Earnings: Can Performance Catch Up to Valuation?

]

GameStop (NYSE:GME) is widely known for its role in the meme stock frenzy. Retail investors who gather on Reddit and other forums to discuss stocks collectively decided the buy and hold GameStop stock.

The concerted decision caused the stock to skyrocket, and it’s up an incredible 1,165% in 2021. That’s despite the company’s deteriorating operating performance over the last several years. It has an opportunity to report improving results when it reports second-quarter earnings on Sep. 8.

Doing all it can do

GameStop has a long way to travel to justify its sky-high valuation. The stock is trading at $218 per share. However, in its fiscal 2019, 2020, and 2021, the company lost $6.59, $5.38, and $3.31 per share, respectively. $3.78 was the highest earnings per share it reported over the last decade, and that was in fiscal 2016. So GameStop stock is trading for 57 times the $3.78 of 2016, if you are willing to base its valuation on multi-year records rather than on the company’s current performance.

Not a big deal – several companies trade at price-to-earnings ratios as high or even higher. The caveat here is that it was the company’s best year in the last decade, and it is unlikely to reach that level again. The gaming industry is increasingly moving toward digital sales, and GameStop largely sells physical copies of games. The trend is unlikely to reverse. Gaming companies can earn higher profit margins by selling digital downloads than from physical copies of games they have to make and ship to customers.

However, it’s important to note that a group of high-frequency gamers strongly prefer buying physical copies of games. That’s because when they are through playing a game, they can turn around and sell it. In fact, this is where GameStop thrives by buying and selling used games from consumers. This is further supported because game developers are selling digital copies for the same price as physical copies, offering no incentive other than convenience for folks to choose digital.

What this could mean for investors

Management is making the right moves: It’s decreasing GameStop’s store footprint, raising equity by selling shares at inflated prices, and using the proceeds to pay down high-interest-bearing debt.

And sales are moving in the right direction, albeit off a low base. Revenue increased by 25% to $1.3 billion in the most recent quarter. That’s even though the company reduced its store count by 12%. Still, it wasn’t enough to break even, and the company reported an operating loss of $41 million in the first quarter.

Analysts on Wall Street expect GameStop to report revenue of $1.12 billion and a loss per share of $0.66 in Q2. Revenue is improving as economies reopen, but there is no telling when the company can generate profits annually.

There is some hope that next-generation consoles will generate enough interest in gaming that the company will benefit. Still, manufacturers have made available digital-only consoles that cannot be used with physical copies of games. As a result, it looks to be long before the company’s operating performance can live up to its expensive stock price.