The stock market took a turn for the worse Monday afternoon, largely erasing the morning's small gains. The tech-heavy Nasdaq Composite was hit hardest, with many expensive growth stocks feeling some pain.
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Troubled video game retailer GameStop (NYSE: GME) managed to stage a rally on Monday in the lead up to its second-quarter report, while shares of Shopify (NYSE: SHOP) were unable to be saved by an analyst price target bump.
GameStop jumps ahead of earnings
Video game retailer GameStop won't report its second-quarter results until after the market closes on Tuesday, but investors are already bidding up the stock. The stock has been volatile ever since Michael Burry, known for profiting from the housing bubble, announced a stake in the struggling retailer. Shares were up 9.7% at 1 p.m. EDT.
Image source: Getty Images.
Burry's rationale is based on the numbers, as well as an expectation that the next generation of game consoles will provide some relief. GameStop stock was trading for less than $4 per share at the time, good for a market capitalization of about $290 million. With $480 million of cash, Burry argued that GameStop should buy back most of its outstanding shares to dramatically boost earnings.
It's true that share buybacks would increase per-share earnings, but that only remains true as long as GameStop remains profitable. The company's revenue and earnings have been plummeting as console game sales shift from physical discs to digital downloads. What's worse, the cash-cow used games business is in freefall.
Next-generation game consoles will certainly help GameStop in the short run, but the main product the company sells, physical game discs, is on its way to being obsolete. A massive buyback would deplete much of the company's cash, which is its most important asset as it struggles to find a way to survive.
The market has become a little more optimistic on GameStop since the Burry news, and the rally on Monday adds to those gains. But another weak report on Tuesday could send the stock tumbling anew.
Shopify tumbles despite analyst optimism
Analysts at Baird gave Shopify some love on Monday, maintaining an "outperform" rating and raising their price target from $370 to $410. The price target bump was driven by the expectation that Shopify could surpass eBay to become the second largest e-commerce platform in North America by the end of the year.
The market didn't share Baird's enthusiasm -- shares of the software-as-a-service provider were down 6.9% at 1 p.m. EDT. The stock's stratospheric valuation, combined with recession, trade war, and bear market fears, appear to be just too much to overcome.
Shopify was worth nearly $43 billion prior to Monday's slump, giving it a price-to-sales ratio of 32. The company isn't profitable on a GAAP basis, although it does produce a small profit on an adjusted basis. Even so, the valuation is deep into nose-bleed territory.
How will Shopify fare in a recession? Its platform may be mission-critical for many of its customers, but its customer base is comprised of a large number of small businesses, and some of those customers will inevitably fail in an economic downturn. The company is probably not recession proof at all.
With a price target boost no longer able to propel Shopify's frothy stock even higher, trouble could be on the horizon for investors.
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Timothy Green has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Shopify. The Motley Fool owns shares of GameStop and has the following options: short October 2019 $37 calls on eBay and long January 2021 $18 calls on eBay. The Motley Fool recommends eBay. The Motley Fool has a disclosure policy.
This article was originally published on Fool.com