Note: This blog series describes an investment idea in retrospect that was analyzed and predicted months ago.

As evidence that the research and pick was made in June 2013, I directly reference those that saw this analysis last year.

Bill Babeaux – Instacart
Adam Millat – Millat Industries
Andrew Virata, Marisa Mulac- JPMC
Kateryna Parke – Houlihan Lokey
Mintai Wang – Factset
Nate Palmer – Diamond Hill Capital

If someone had shorted Gamestop as this research suggests from the date in the email below to Bill (August 4, 2013) to today, they would have earned 25.28% compared to the S&P 500 return of 7.55%.

After talking to some of these individuals about the stock’s tanking the past few weeks, I have decided to turn this research into a series of blogs.

As an employee of JPMorgan’s Investment Bank, our trading and social media presence is supposedly limited. However, since I am not on the side of the business that would deal with Gamestop’s stock and the move has already occurred, I feel that blogging my research is worthwhile.

These guides are meant to be informative so you can use them to learn finance and value companies yourself. Stocks are constantly moving. Although I believe Gamestop still has further to drop, the analysis presented here is already somewhat out of date.

Last note: The research is also available for download.

An Introduction to Discounted Cash Flow Analysis:

How do I know if a stock price is too high or too low? How do I know what to buy and sell? These are the basic questions most people ask about stocks. My goal is for this blog series to give my readers a glimpse into the techniques investment bankers and professional investors use to answer them.

A lot of people have heard of “financial models”, but have no understanding on what the term means. While there are numerous meanings for the phrase, most models involve using pre-existing information, putting the information into a formula, and the formula will give you the answer to your question. If, as a layman, it sounds intimidating, don’t fear; it’s mostly arithmetic.

The one particular model we will learn about is a system for taking information about a company with publicly available stock and how to determine the value of the stock: Discounted Cash Flow Analysis.

Discounted Cash Flow (DCF) analysis is predicated on one core idea: A company’s value is determined by how much cash it will make for the foreseeable future. Hence “Cash Flow analysis”. The “Discounted” word means that cash the company earns in the future is worth less than cash they earn today because the future is unknown and risky, so we “discount” future cash. This principle is called the Time Value of Money.

The next question: How do we know how much cash a company earns? This question and answer should be split into two parts: First, how do we know how much cash a company has earned in the past, and second, in the future?

Answer one is that every company with stock that is “publicly traded” (available for anyone to buy) must file publish their accounting statements with the Federal government’s Securities and Exchange Commission, the agency responsible for enforcing legislation regarding financial markets. Often companies publish these reports on their websites as well (our example company, Gamestop, maintains a website for investors). Companies have to release their financial information by law so that individuals such as ourselves and professional investors can make the very investing decisions we will make in this essay.

However, since we obviously do not know how much money they will make in the future, we have to do some predictions. This is when we can use the DCF model.

To demonstrate the use of a DCF model, I will analyze a stock I believe to be overvalued: Gamestop, the video game retail store.

Stock Price Predictions:

“Current” Stock Price (as of August 4, 2013 when analysis was finalized):

$50.29

Today’s Stock Price (February 4, 2014):

$33.83

My DCF Model Stock Price Valuation:

$23.78

Thesis:

Gamestop is the self-described world’s largest multi­channel videogame retailer. They sell new and pre­owned video game hardware, physical and digital video game software, accessories, as well as PC entertainment software, new and pre­owned mobile and consumer electronics products and other merchandise.

The original research was inspired by the idea that what had happened to movie, music, and book retailers would happen to videogame retailing as well, specifically the loss of sales to big box and online retailers with broader reach in terms of marketing and logistics, improving game streaming technologies supported by the console makers, and the digital distribution of games.

The results of the research show that Gamestop is overvalued. The management has a strong retail background and has paid down all of the company’s debts, but little to no technology expertise. Despite a large cash reserve saved from boom years and still strong free cash flow, management has elected to return this cash flow to shareholders via stock buybacks and dividends. This is a move I disagree with, as it signals to me the company is not investing enough on addressing the long term trends that will, but have not yet, devastated its core retailing business.

Next: Supporting Arguments