Broker Check
What is happening with Gamestop Stock?

What is happening with Gamestop Stock?

January 28, 2021
Share |

GameStop is all over the news today.  Their stock (GME) opened up this year at just over $17 / share.  Today (January 27, 2021) it traded as high as $380 / share.  It is a video game retailer with over 5,000 stores.  They reported over $1 billion in sales for the most recent quarter (down 30% from last year).1  Is GameStop the next big thing?  Is it another Amazon?  The quick answer is no.  In my opinion, GameStop is closer to the next Blockbuster than it is the next Amazon.  I feel that the stock is worth closer to the $17 than the $380.  So what is going on and why the sudden increase?

Essentially, this is a short squeeze at heart.  It has been exacerbated by a few other circumstances that are occurring at this time. There has been a lot of negativity about GameStop based on the fundamentals of the company.  After all, GameStop is a brick-and-mortar video game realtor at a time when games have been moving to an online purchase model. The company lost over $18 million in their most recent quarter.1 The overwhelming consensus was that the stock was going to decline in price, and as a result Wall Street investors had sold the stock short to a tune of almost 140%. In other words, they sold more shares of stock than actually exist.  

What does it mean to sell the stock short?  When someone sells a stock short, they are selling a stock that they do not own.  They are essentially "borrowing" the stock, selling it, and promising to pay it back later.  If the short seller is right, and the stock goes down, they buy the stock back at a lower price and keep the profit.  They are rewarded if the stock price goes down.  If the price goes up, the short seller has to buy the stock back at higher price and loses money.  The institution that "lent" the short seller the stock can demand repayment or additional funds in order to make sure that the borrower will be able to repay the stock loan.  If the borrower cannot add funds, the institution can demand payment, forcing the short seller to have buy the stock back. This creates additional demand for a stock, which in turns causes the price to go up, leading more firms to demand repayment from short sellers, which causes even more demand for the stock and the price to rise further.  This creates an unnatural supply demand imbalance which is not based on anything that the underlying company does. This is called a short squeeze (short sellers are being squeezed out of their positions).  A stock can go unnaturally high for no other reason other than short sellers are forced to buy stock from sellers that do not want to sell and demand a high price.

The GameStop short squeeze has been exacerbated by a few other circumstances that are occurring at this time. GameStop is a fan favorite amongst gamers.  Diehard fans have gathered on a Reddit forum (WallStreetBets) and were determined to "save" the stock out of loyalty to the brand.  This has turned into a crusade to take the short sellers of GameStop down. This was done by purchasing large amounts of GameStop shares causing the price to rise, setting off a scenario described above.  In the past, this was done via secret deals by large investors.  In this case, it was presumably started by a few gamers on an online message board that banded together.  At this point, it has become more than a few loyalists trying to battle the "big bad" short sellers.  It has been compared to economic populism. 

Another thing fueling the fire is the incredible amount of new “traders” in the market.  During the pandemic, millions of people flocked to “play the stock market” with varying degrees of success.  Since the bottom in March of 2020, the market has gone almost straight up (minus a few hiccups).  People with little knowledge and experience are feeling overconfident based on a few trades.  While I am not dismissing anyone, many people have no strategy other than to buy what is going up. Regulators often worry about inexperienced investors being preyed upon by Wall Street.  There is a large amount of money at stake here. These large amounts of money being made and lost have nothing to do with the success or failure of GameStop as a brand. Quite often, this story ends with most of the experienced investors selling the stock at the top to inexperienced investors, with the latter absorbing a substantial portion of the losses when the madness ends.  Unfortunately, we have seen this pattern repeat throughout history.  One thing is for sure, Gamestop will not be the last stock that we see this happen to. The big question now is are there professionals at work manipulating the stock, or is this simply individuals colluding online in order to drive prices artificially high.

My advice to our clients – stay out of it!  This is not in any way, shape, an investment opportunity.  This is a pure gamble at this point. One thing, in my opinion – this stock will go down substantially. The surge in prices was fueled simply by supply and demand, it has little to do with the actual price of the stock.  So much so, that the LA Times calls trading in GameStop “Stupid”.

https://www.latimes.com/business/story/2021-01-26/gamestop-short-squeeze-stupid

 

A quick study of history will lead you to a handful of stocks that a similar “manipulation” has happened to in the past:

 

Tilray – Company went public in the $20s in 2018 and quickly moved up close to $150 in a frenzy.  It reached as low as $2.43 and is currently trading at around $20.

Volkswagen – In 2008, during the housing crisis and great recession, Volkswagen was struggling and teetering on bankruptcy.  The stock traded at €30 in 2005.  It increased to €200 by 2008.  Figuring it was overvalued, it was highly shorted.  When the squeeze started, the stock hit €1000 in just a few days, briefly becoming the most valuable company in the world.  In this case, Porsche was behind the squeeze as they had virtually locked up all the shares in Volkswagen.  In 2008, Porsche made 8 times the amount of money trading (in virtually one stock) as they did selling cars.  For reference, Volkswagen is still trading under €200 over 12 years later.

Hertz – Shortly after the pandemic, the company filed bankruptcy.  This typically means that the equity holders are wiped out and the stock goes to zero.  The stock was delisted from the NYSE and quickly traded down to $0.56.  Somehow, the stock still shot up to over $5 in June 2020.  The stock is all essentially worthless, but demand from investors exceed supply.  This quickly passed and the share price is less than half of that and most likely heading to zero.

 

As stated earlier, in most cases the retail investors were the vast majority of buyers at the top.

 

So what lessons can we learn from this so we do not get burned?  Here are some key takeaways:

 

1).  Before investing, ask yourself why.  If you can’t explain why, don’t invest.

2).  Understand what you are investing in and how the company will return enough profit to make the investment worthwhile.

3).  Consider your overall strategy and determine whether the particular investment fits that strategy.

4).  Do not get caught up in the news of the day.  You would not purchase a business based on a news story without any due diligence.  Do not purchase a stock without doing due diligence.  Sometime the 24 hour news cycle makes us feel anxious, and as if we have to act.  Avoid FOMO.

5).  Buying a  stock like this is not investing, it is pure gambling.  I refer to it as the “bigger sucker theory”.  The only way to make money is to find a bigger sucker to pay you more than you bought it for.  If you insist on buying, do NOT do it in any of your serious investing accounts.  Open up a play account that you do not consider part of your investment strategy and plan on losing all of it.  Some people call this a "Las Vegas" account.

6).  If you sell short (which we typically don’t), understand the risks.  When you buy a stock, the most that you can lose is 100% of your investment.  Your potential gain in theory is unlimited.  When you sell short, the most that you can gain is 100%.  Your potential loss is unlimited.

With this particular stock, there will be investigations and possibly prosecutions if there were any laws broken.  Some people will make a lot of money, many will lose.  Many will try to buy on the way down thinking that it will come back (I don't think that it will EVER reach current prices in the future).  Future generations will be reading about this stock in financial textbooks.  This is not normal rational behavior.  The stock, where it is right now, is not an investment.  It is purely a short term gamble.  If you decide to buy into something like this, make sure that you understand the risks.

 

 1).  Google Finance, January 27, 2021