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Better Buy: Costco vs. GameStop

It doesn't seem like a fair fight. Pitting Costco Wholesale (NASDAQ: COST) against GameStop (NYSE: GME) seems to have all the makings of a financial blowout. Costco is a rock star warehouse club operator with a future that brightens with every passing year. GameStop is a struggling small-box retailer clinging to fading remnants of the physical distribution of video games.

However, pull up the stock charts and things start to get interesting. Costco has been a steady producer, and its 30% year-to-date gain is trouncing the market's 12% climb in 2020. GameStop's performance puts both of those measuring sticks to shame. GameStop shares have nearly doubled this year, up 98% through Monday's close. GameStop stock has more than quadrupled since its springtime bottom. Suddenly this bout of two very different retail chains gets a lot more interesting.

Image source: Getty Images.

Mind the gap

There's a mammoth difference in scope between Costco and GameStop. A Costco warehouse averages 145,000 square feet. It's a giant. GameStop occupies small-box locations in strip malls. The typical store takes up less than 2,000 square feet.

A few years ago no one questioned the GameStop model. It was a cash cow, largely because of its small size. There was little overhead with the small leased spaces and minimal staffs. Customers spent big bucks on video games, consoles, and accessories. GameStop would use the money raining in to bankroll beefy dividends and aggressive share buybacks that would improve profitability on a per-share basis.

It's a different world these days. Net sales are declining sharply for the third year in a row. This will be the third consecutive year of steep losses. The last of the quarterly dividend checks went out 20 months ago, and there's no hope of those payouts returning anytime soon.

Digital delivery has doomed GameStop. It still sells hardware -- when a more nimble e-commerce player doesn't score there first -- but that has always been its lowest-margin business. GameStop's model in its prime feasted on the resale of games and gear, always its highest-margin business. Gamers still buy hot new titles, but developers and console makers now reach out to players directly to extend the life of the physical diversions.

GameStop did trigger a huge short squeeze last month after announcing a deal with Microsoft (NASDAQ: MSFT) ahead of this month's new Xbox launch. Microsoft will help improve GameStop's back-end solutions, but the retailer will also score some downstream revenue from everyone it nudges into Microsoft's ecosystem. It's a savory notion, but GameStop is ultimately grasping at straws here. The slow fade will continue.

Active stock

Costco is holding up a lot better despite its shares being a relative laggard to GameStop. As GameStop retreats, Costco grows. It's not up to 800 warehouse clubs worldwide. Costco has actually gotten better during the pandemic. Adjusted comps soared 14.4% last month, following similar year-over-year bursts in the low teens through the summer.

Costco's payouts will never match peak GameStop, but that's not a bad thing. Capital appreciation is the real driver here. The 0.7% yield is just a diversion, but every so often Costco comes through with a special one-time distribution like the $10 a share dividend it announced on Monday.

There's no denying who is the better retailer, and it's Costco by a country mile. However, investors want to know which one will be the better retail stock -- and that's an entirely different question. GameStop has battled back since being discarded weeks into the COVID-19 sell-off earlier this year. There are a lot of people betting against GameStop, explaining why it's been able to surge on pedestrian news. A short squeeze can be wonderful thing to see if you're long a stock.

I won't shock you. I'm still tapping Costco as the better stock. GameStop's going to have a few spikes on the way down, but that's ultimately where it's heading. Activist investors rattling the cages can't help change reality here. Costco is the one that will continue to ascend in popularity, and that ascent will also apply to the warehouse club operator's all-weather stock.

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Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Rick Munarriz owns shares of Costco Wholesale. The Motley Fool owns shares of and recommends Costco Wholesale and Microsoft. The Motley Fool recommends GameStop and recommends the following options: long January 2021 $85 calls on Microsoft and short January 2021 $115 calls on Microsoft. The Motley Fool has a disclosure policy.


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