The GameStop (GME) Saga
Shares of GameStop (NYSE: GME), a video game and consumer electronics retailer that had been struggling for years as physical retail sales declined and as consumers shifted their spending behavior online, amplified by the global pandemic, soared after calls from the Reddit forum r/wallstreetbets to save the retailer from Wall Street hedge funds looking to make a quick buck on a declining business went viral. What happened after was something fit for the big screen and evidently, will be, as Hollywood looks to memorialize the event. The stock, which had been trading around $5 a share at the beginning of the year, dipping down to a 52-week low of $2.57 a share, shot up to a 52-week high of $483 a share in a matter of days as legions of individual investors banded together snapping up shares on an app fittingly named RobinHood, costing hedge funds billions in losses. And suddenly, it became much more about investing in a single stock, it became a story of how average, retail investors can stand up to the might of Wall Street greed.
What happened exactly?
If you are a bit fuzzy on the details and asking yourself what a “short squeeze” is and how there can be a battle over a single stock, you aren’t alone. Let’s first understand what a short-seller is and what they attempt to do. A short-seller makes money by first borrowing shares (i.e. goes into debt) at the prevailing market price in the hopes that the stock price declines in value from when they originally borrowed the shares. If the stock price declines, the short-seller can purchase those shares in the open market, give them back to the lender they originally borrowed them from and pocket the difference between the price they borrowed at and this new, lower market price, less any interest charged on the loaned shares.
This is what the Wall Street hedge funds were doing with GameStop. They saw a business on the decline that they felt was overvalued and employed a strategy to capture what they saw as a mispricing in the market. This is one of the same strategies depicted in the movie “The Big Short” where traders made billions of dollars from the housing crisis and most recently, used against Tesla quite unsuccessfully as billions more were lost betting against Elon Musk’s vision. It’s a common tool in their arsenal to make money for their investors as markets move up, down or sideways. This strategy is a bit harder for individual investors to employ, but more on that later.
So what, then, is a short-squeeze? A short squeeze is when the price of that borrowed security rises significantly, squeezing the short-seller out of their position. Recall that a key component in the short-selling strategy is that the short-seller needs to go out into the market and purchase the shares they borrowed (ideally at a lower price). If they don’t move quick enough as the stock price rises, they can face significant losses as they try to purchase the stock at a higher premium, not to mention pay off the interest on the privilege to borrow those shares in the first place. Users on r/wallstreetbets understood this strategy and that’s why they sounded the rallying cry, to punish the Wall Street hedge funds for trying to make money off of a failing business.
Why GME isn’t a solid investing strategy
As of publishing this blog post, it looks like the wind in the GME sails have all but petered out as it’s currently trading at ~$49 a share. Even though the current price is trading at a tenth of what it was at its peak, that doesn’t mean it is a good deal. Here’s why:
There have been zero changes in GameStop’s business model or the ecosystem they inhabit
They didn’t make a game-changing acquisition that has the potential to revolutionize/modernize the business and make them more competitive
No regulations have changed to give them an advantage over their competitors
They haven’t experienced a financial windfall, nor have they benefited from any large tax laws recently passed to justify their meteoric rise in stock price
And with little to no change in any of these areas, one would think the stock would be trading at roughly the same price it had before the run up. But once you don the investor hat, these are the factors you must consider before jumping in, especially with any sum you shouldn’t or can’t part with. And unfortunately, as in any speculative stampede, there will always be those who lose their shirts taking on too much risk.
The Big Questions
There is a compelling argument that more democratization is needed in the investing world, especially during the pandemic when the income gap and wealth inequality are rising. GME’s rise “to the moon” might be over, but the conversation around it isn’t, including questions such as:
Should (more) investors have a right to make money in a down market and gain access to short-selling and margin lending?
Is it unethical to make money betting against a company?
Did r/wallstreetbets engage in the SEC’s definition of market manipulation where users encouraged others to buy and hold?
How does this compare to hedge fund managers appearing on large media outlets such as CNBC to espouse a position they may or may not have a financial interest in?
What rights do individual investors have with regard to unfettered access to buy and sell stocks?
Was RobinHood in the wrong to halt and limit trading?
These broader implications will take time to sort out, and the debates will continue. And much like the other meme stocks out there, theGameStop saga represents more of a cultural flashpoint rather than a viable short-term investing strategy. Ultimately, I’d recommend observing the ongoing battle between Main Street and Wall Street from a safe distance.
