GameStop and the Rise of Meme Trading

Brian Burton

Apple, Microsoft, and Facebook all reported earnings last week and somehow the results were buried behind article after article on a video game retailer involved in two industries on life support, selling discs and mall stores.  So why all the hype for a company with revenues down 45% over the last decade and whose profits have turned into losses?  Well, when the share price of a company trading at under $5/share this past summer climbs to over $400/share while also becoming the world’s most heavily traded stock, it garners some attention.  And it wasn’t just GameStop (GME), there were many other written-off companies (AMC Entertainment, Blackberry, Bed Bath & Beyond, etc) that saw their stock price go parabolic over the last two weeks for no apparent reason.  Let’s take a look at how a company like GameStop who many believed was going to follow Blockbuster down the path of bankruptcy, can experience such a meteoric rise in its stock price.

It all really started when Ryan Cohen, the co-founder of Chewy (online retailer of pet products), bought a large position (9 million shares) in GME last year.  He made a bullish case for the stock, arguing publicly that the company should transform itself into the Amazon of video games.  He and two of his associates later received seats on the board of directors for GameStop, and by that time the stock had gone from $5 to $20.

Nothing too abnormal so far, an activist investor taking a few seats on a board of a highly depressed company with big plans of a return to glory, but what happened over the next couple weeks was anything but normal.  The stock went from $20 on Jan. 12 to over $450 on Jan. 28, a 22x return over the course of only 11 trading days!  This dramatic move in the share price caught the attention of so many, I even had friends and family that never discuss specific stocks texting and calling asking, what in the world is going on with GameStop?  I could write for days on the details of why and how but I’ll do my best to spare you and keep it brief.

There is a forum on the discussion website, Reddit, called WallStreetBets where 3.5 million users come together to discuss highly speculative trading ideas.  These aren’t your average investment discussions on value vs. growth, it’s almost as though this group has their own language through the use of memes (a type of idea, behaviour, or style that is spread via the Internet, often through social media platforms and especially for humorous purposes…think Bernie Sanders in mittens) and emojis.  With GameStop, AMC, BB and others, the theme (or meme) was to spot written-off companies that were heavily shorted (huge bets that the stock price will go down) and buy, buy, buy (mostly call options) until the price moved higher and higher, ultimately creating a short-squeeze.  That’s exactly what happened, when the price of these stocks rapidly moved higher from the heavy call option buying, many of the hedge funds that were heavily short were forced to scramble and buy back shares to cover their short positions, causing the prices of these stocks to move even higher.

This activity where a large number of traders all pile into a shared idea based on their internet fluency or “meme literacy” is being referred to as meme stock trading.  The dramatic rise in the “meme stocks” is being attributed almost entirely to this trading strategy.  The WallStreetBets crowd was using heavy call buying (low-cost, risky bets) to push share prices higher.  Option trading is handled by market makers who often buy shares of the underlying stock to hedge call buying, pushing prices higher, and in the case of GME, ultimately into a short squeeze.

It has been interesting that on days when the “meme stocks” are way up, the broad market is selling off and vice versa.  It’s almost as if Wall Street is saying we don’t know exactly what’s going on here but we’d be a lot happier if it would stop.  No one knows for sure how this will all play out but it has been fascinating to watch from the sidelines.  It brings back memories of the late 90’s when newsletters with “hot new stock tips” were circulating, causing money to pour into companies with unfounded valuations, many of which ultimately flopped.  The two biggest differences now vs. the dot.com days is that today we are all connected through the internet, providing greater idea sharing and heightened FOMO (fear of missing out), and almost everyone has a smart phone that brings trading to our fingertips.

Please notice that I mentioned “from the sidelines” in the previous paragraph.  At Ballast we do not participate in this type of speculative, short-term trading.  We have formulated a very diligent and highly disciplined investment process that we lean heavily on, particularly during times of market uncertainty.  What we are seeing in these “meme stocks” is more a form of gambling than it is investing and carries an extreme amount of risk; we are focused on strategies with proven track records over the long-term.

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