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GameStop (NYSE:GME) stock soared 50% in early morning trading. It is now down to “just” 38% in the green but is still the top-trending stock on Yahoo Finance after the company surprised the Street by reporting a fourth-quarter profit last night, excluding certain items. But GME’s move into the black appeared primarily fueled by cost-cutting and inventory reductions. The firm’s revenue actually dropped slightly compared to the same period a year earlier.
As a result, the sustainability of the retailer’s profitability going forward is questionable.
Can Gamestop Keep Cutting Its Way to Profitability?
GME’s reported Q4 earnings per share of 16 cents, excluding certain items, representing the company’s first positive, adjusted EPS in two years.
But the company’s sales actually fell 1.2% YOY, so the change in the top line was obviously not a factor behind the firm’s surprise move into the black. Instead, the company’s surprise profit appears to have been caused by a reduction in the total amounts of its two key spending categories: cost of sales and Sales, General, and Administrative Expenses (SG&A).
GME’s cost of sales fell to $1.727 billion from $1.876 billion during the same period a year earlier. Meanwhile, its SG&A spending sank to $453.4 million from $539 million.
The cost of sales decline appears to have been caused primarily by a drop in the value of the company’s inventories. In contrast, the SG&A drop was likely triggered mainly by the massive layoffs that GME had undertaken recently.
But the company’s ability to keep liquidating inventory rapidly in the future is questionable, as video-game sales are generally not climbing a great deal while downloading video games is becoming much more popular than buying physical games.
And usually, companies can’t continuously keep laying off large numbers of their employees without causing their revenue to decline meaningfully.
The Implications of the Q4 Results for GME Investors
GameStop’s Q4 profit is good news for the owners of GME stock, and even after today’s rally by the shares, they have a reasonable forward price-sales ratio of 1.5. Still, with the company reducing its focus on e-commerce and the sales of physical video games plunging, it isn’t easy to see how GME can grow or remain profitable going forward.
On the date of publication, Larry Ramer did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.