My Take: The Fuss about GameStop

We prefer to focus on long-term investing and encourage our clients to do the same. And, while it’s best to ignore the “noise” of the markets, sometimes it’s too much to disregard. So, this is our take on GameStop and what all the fuss is about. If you’re curious about Reddit chat groups, hedge funds getting short-squeezed, and speculative bubbles reminiscent of the 1660s Tulip Mania in Holland, read on. Otherwise, we don’t think this phenomenon will affect long-term investors’ portfolios.

As Derek Thompson succinctly put it in The Atlantic on Jan. 28:

“The GameStop saga is a ludicrous stock mania born of pandemic boredom and FOMO, piggybacking off of a clever Reddit revenge plot, which targeted hedge funds, who made a reckless bet on a struggling retailer—and it’s going to end with lots of people losing incredible amounts of money.”

GameStop (GME) is a retailer of video games with stores located in shopping malls across the country. Unfortunately, this isn’t a great business model and the stock price fell steadily from around $50 per share in 2015 to below $4 per share by the end of 2019. In the later part of 2020, a chat group on Reddit called “Wall Street Bets” focused interest in GameStop stock with posts suggesting the stock was a good buy. Meanwhile, Ryan Cohen, the founder of Chewy.com (the pet good retailer) acquired 12.9% of the company’s stock for $76 million at $8.43 per share and garnered three board seats, pushing the company to transform into a specialty e-commerce retailer.

Watch my colleagues Tim Mauer and Jared Kizer, Buckingham’s Chief Investment Officer, discuss the story at Ask Buckingham.

What’s Reddit? Short answer: It’s a social media site with a focus on discussion groups. Wall Street Bets (a “subreddit”) has a fast-paced “rude and crude” culture that’s supposed to be irreverent and fun for members. Long answer: Ask one of your kids or grandkids (or borrow one)!

While Reddit (and similar social sites) provided the communication vehicle, “retail” brokerage platforms like Robinhood have further democratized investing in stocks and options with “commission-free” trading. As Jason Zweig of The Wall Street Journal once put it, stock-brokers used to pick your pocket, now the broker is in your pocket (i.e., on your phone).

Notably, licensed professionals are prohibited from collusion and other potential market manipulation; “retail” investors are not. With internet message boards for coordination, they, like schools of smaller fish, learned to flash and confuse the larger sharks.

By the end of 2020, GME had risen to nearly $19 per share. Meanwhile, the company’s revenue has suffered because of the pandemic (it’s a physical retailer, remember) and it was losing money. This attracted the attention of short-sellers on Wall Street, the hedge fund Melvin Capital to name one. In contrast with typical investors who make money when stock prices go up, short-sellers make money when stock prices go down. Short-sellers are attracted to stories where they think a rising stock price is “too good to be true.” They sell in the hopes of buying later at lower prices. To learn more about short selling, check out this explainer on NPR: So What Is Short Selling?

GameStop stock rose from nearly $19 per share to around $42 per share on Inauguration Day. While that’s a ten-fold increase in a little over a year, this is a story most people haven’t heard about. And, if they did, they’d likely dismissed it as a classic “longs-versus-shorts” battle on Wall Street (which side will break the other and “win” the game?).

As the stock price rose, however, short-sellers were losing more money and had to post increasing amounts of collateral to their lenders. Some gave up and bought the stock, “closing out” to realize losses. This buying (short covering and more retail) became a feedback loop, causing yet more buying and a “short squeeze” (where many short-sellers are squeezed out of their trades).

But here’s what’s different: The motivation for the Wall Street Bets gang is two-fold. They want to make money. But more importantly for some, they also want to inflict pain on Wall Street – to beat the rich at their own game (“stick it to the man”). Echoing Occupy Wall Street back in 2012, they’re angry about wealth inequality and “rigged” financial markets. Financial markets, though, are based on participants behaving rationally and in their own financial interests. This move from organizing in the street to on the “Street” makes this important; market professionals are not used to this.

And boy, the retail-driven buying worked. GME popped to $120 per share on Jan. 25, eventually hitting $468 per share on Jan. 28 in volatile trading before closing that week at $328 per share. The hedge funds, caught in a massive short-squeeze, either closed out their positions, recognizing billions in losses, or sought bailouts to cover margin calls to maintain their positions. Melvin Capital reported a 53% loss for January (largely attributed to its GameStop bet).

What’s next? Regulators, exchanges, and brokerage firms are empowered to ensure orderly markets and will continue to impose necessary trading limits. For example, Robinhood announced purchase limits on GME (to one share per account) and other company stocks.

Where does this game stop? As of the end of January, GME stock was still the most heavily shorted stock in the market, with a short interest of 121.07%. The standoff may continue for a while – if the short-sellers can continue to finance their positions and the Wall Street Bets folks “hold the line.” For many of these retail investors, “holding the line” means not realizing gains that are potentially life-changing (enough to pay off student loans, buy new cars, or make house down payments). But once the line breaks, the price decline could be dramatic and many of the “protesters” will be left holding the bag.

According to CNBC, GME was trading at $63.50 in afterhours trading on Feb. 5.

Bottom line: We continue to monitor the story but note that its impact on the broader market should be minimal. To put things in perspective, at current valuation GME has a market capitalization of $6.5 billion compared to over $40 trillion for the S&P 500.

Stock price data from Nasdaq.com. R-21-1773