It is inevitable as an investor -- in this case, on the value end of the spectrum -- that you'll run into situations that evoke the question, "What is wrong with this picture?" Names will be beaten up to the point that you wonder whether the market has gotten it all wrong and that the punishment might not fit the crime. If you are right and take a position, the rewards can be staggering; buying what others have sold at rock bottom prices can be a winning strategy. It also can rob you of your capital if the markets were right all along.
The hard part is making the determination of whether a distressed situation is a falling knife or value trap, or alternatively a real opportunity. Sometimes you can be enticed to but based solely on a big down day in a particular name; I've done this from time to time over the years and would not recommend it unless you have the discipline to close the position quickly if it does not go your way. Otherwise, you may end up holding on to a name that has no business in your portfolio simply because you thought you could scalp it for a quick profit but can't stomach the loss.
Short-term scalping is best left to the technicians, where the emotion is left out of the equation. It is one thing to know a name well, have it on your radar and buy on a dip, and quite another to buy something you know little about on a dip, intending to sell it quickly. That's gambling.
That brings me to a couple current situations I'll focus on over a few columns. They are enticing on some level, but the markets are suggesting they may be doomed and is pricing them accordingly.
GameStop Corp. (GME) has seen its shares tumble from the mid $50s in 2013 to close Thursday at $4.23. This one has popped up on some of my value-inspired screens several times over the past few years, appearing to be cheap on several metrics. I've always passed, even last month after GameStop's Dutch tender auction, and GME has ended up being a value trap and a falling knife so far. But there may be a level at which even the most distressed name is actually cheap, and I am wondering whether that is the case now.
Recent action in GME has been interesting; shares closed at $3.21 on Aug. 15 and are up 32% since then, for some interesting reasons.
First, Mike Burry of Scion Capital Management disclosed a 3% position, publicly stated that he believes shares are cheap (in a recent Barron's article), and sent a letter to GameStop's board of directors on Aug. 16 urging them to use their full current buyback authorization. Then, on Thursday, GameStop announced changes to its website after customer complaints and shares rose 9%. While I'm not sure Thursday's bump was solely due to website changes, there is another factor at work here, and it's potentially a big one: as of July 31, short interest in the video game retailer was an incredible 57 million shares, about 63% of shares outstanding.
In summary, you have a distressed name in a distressed industry, with huge levels of short interest, that is starting to gain attention from institutions and trades at about 2.5x next year's consensus estimates (with nine analysts weighing in). It ended the latest quarter with $543 million in cash and $469 million in debt, but has reduced that debt by $350 million over the past year and eliminated the dividend.
What, if anything, is wrong with this picture?