Stocks on Steroids or Irrational Optimism?
What better way to explain rotten investments than with meme stocks? According to Charles Schwab, 20% of all investors started in 2020. This retail crowd knew little about the stock market and even less about its dangers. The only thing most people cared about was making money fast. Intoxicated by the faulty promises of spectacular returns, they flocked to the “hottest” thing. We all know how shiny the promises of potential returns can be.
This is what happened. A group of Reddit users, who branded themselves “Apes”, suddenly started to promote a few companies as the next big thing. Eventually, this brought in a huge crowd. With each new follower, the stock price grew. A sense of optimism and prosperity held the Apes together as they “diamond-handed” GME, AMC, BBBY, etc. “Diamond hands” is a term used to describe an investor that is refusing to sell. GameStop (Ticker: GME) jumped from $17.69 to $325.00 in one month. Absolutely baffling returns. Other so-called “meme stocks” followed. The parade of ridiculousness ended with GameStop back at $40.59 two weeks later. The real winner was the 1% who bought before everything started. Most suffered heavy losses, but it’s no surprise that people were hooked.
Praying as a group inside a burning building might give you optimism, but in the end, you will burn. You might have a better chance of survival by abandoning the risky building before the roof collapses.
Nevertheless, some investors are still refusing to jump ship. As a result, GameStop has been jumping up and down in recent months (currently around $146). What can you expect in the future? For the sake of brevity, I will condense the logic as much as possible.
GameStop has been dying for quite some time. Their core business is selling video games and related products/services. Those that like to play around on the computer and consoles know that in-store buying is outdated. These days, everything is online. The trend is clearly visible in the financial statements too. GME’s revenue has been declining and they have not recorded a profit in five years. They are constantly taking on more debt and issuing more stock (which leads to share dilution) to get more money. It is a dying business. Why would you expect it to be priced like a growth stock?
The same goes for AMC. They engage in the theatrical exhibition business. There is a certain charm when you take out your significant other to the movie theater, however, “Netflix and Chill” is the more popular option these days. “AMC struggled during the pandemic, but it will rebound soon.” That’s what everyone was saying. However, in reality, the company was not in the best shape before that. The pandemic was just a welcomed excuse to get some extra funding from optimistic investors. They quadrupled the amount of shares issued (from 117 million to 477 million). Then, just when you think they would use that money for something good, they pull the most ridiculous stunt ever. They buy a gold and silver mine. I am not sure how that’s part of their core business. Will they open a theater in the mines?
When the stock price is not in line with the fundamentals, two things may happen. Either the business performance must evolve and catch up to the optimistic valuation, or the stock price will eventually decline to the appropriate levels based on the business’s performance. It’s inevitable.
Our Discord members have made a lot of money trading these stocks based on technical levels, chart patterns, volume, and other indicators, but are they viable investments suitable for your long-term portfolios? Will the Diamond-Handed Apes prevail?
Let us know what you think!