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strategy lab

Chris Umiastowski is the growth investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.

I first wrote about GameStop Corp., a video game retailer, in April, 2014. At that time, the stock was trading at around $40 (U.S.), and the company's market value was about $5-billion. I suggested the company's business model was severely challenged because in the next few years game publishers will stop selling physical disks. The industry is moving toward digital downloaded content. The days of inserting a game disk into a console are numbered.

Since that time, the stock has declined to about $32. If you had invested in the S&P 500 your return would be 30 per cent higher than a position in GameStop stock. While I generally don't like comparisons over short time periods, I think the business likely has a lot more pain to go through. Grapevine, Tex.-based GameStop is a good modern-day example of how a clever, value-added and successful business can be heading toward extinction purely because of technology trends.

Today, physical game disks are still the dominant form of game distribution. People enjoy visiting GameStop stores because they can chat with knowledgeable staff, socialize with other customers and because they can trade in their used games for credit toward new titles. One-stop shopping at GameStop seems easier than selling a used disk on eBay and buying a new game on Amazon. And if you are a teenage kid or young adult with no credit card, a physical store is likely preferable to online purchasing.

GameStop knows digital downloads will replace physical disks, so the company is slowly reinventing itself. As an example, GameStop has become a vendor for digitally downloaded content. Kids or young adults who don't have a credit card can walk into the store, pay cash, and have their digital content downloaded right on the spot. That's convenience, but I don't think it's enough to thrive, or even to survive.

It is essential to understand if major technology trends are aligned with or against a company's business model. On the surface you might think GameStop is not fighting the digital download trend because it is actually selling downloads in its stores. And yes, there does seem to be a demographic who values this service.

But let's think longer term. In 10 years I expect 100 per cent of games will be sold as downloads, not physical disks. There is no such thing as a used digital download, so the trade-in market will disappear. This kills one of the major attraction points for GameStop customers.

The other major area of change is in digital payments. In 10 years will kids really need a credit card to buy a game, or download a new level? Likely not. Even today, Apple has created a system where parents can provide a spending allowance to kids who want to buy music, games or apps on the iTunes store. It's hardly a stretch to think that any business looking to attract money from teenagers will make it very easy for this demographic to pay online without a credit card. Digital purchases are becoming such an important part of how we transact. In 10 years I believe that if you have money in any developed country, you'll have a built-in way to spend that money online. Kids won't need to go into a physical store to pay for a digital download.

Yes, GameStop is trying to reinvent itself. But the way I see it, the fundamental technology trends are only helpful to the company in the short term. Several years out, these trends threaten to wipe out the biggest reason people visit its stores. Far better, I think, to invest in companies that are aligned to these same technology trends. Apple launched Apple Pay recently. Starbucks has a successful digital payment and loyalty platform. We'll never download coffee, so Starbucks will remain a social destination, and technology will make their business better. Gaming is big business but watching TV shows and movies is even bigger. Netflix is riding the trend toward digital content delivery long term, rather than fighting it like the traditional pay TV providers such as cable and satellite operators.

We all like a good turnaround story, and we've all heard the story of David and Goliath. But when it comes to investing, if Goliath is the technology trend that David has to fight, I'm not betting on David. GameStop was a smart and worthwhile business to get into. Unfortunately, I just don't think it was built to last.

Disclosure: The author personally owns shares of Apple, Netflix and Starbucks and holds Apple and Netflix in his Strategy Lab portfolio