GameStop: The War Is On
Greetings to you from the Fort on this drizzly January day. While winter hasn’t exactly been tropical here, it hasn’t been all that wintery either. The group that has the firmest ground to complain about this winter is certainly the snow lovers…even the winter “storm” last night brought ice instead of snow.
Perhaps the winter cold has been sapped by the heat coming from the stock market! The S&P 500 has set new all-time highs, and as of this writing is +3% so far in January. It’s been nice to see the resurgence of some stocks that struggled last year. But the most scintillating storylines have come from the corners of the market that had been closest to the abyss. In case you haven’t tuned in, we’ll catch you up. We feel a duty to educate customers, but also, this subject is so fascinating it’s ridiculous.
GameStop is (primarily) a retailer of video games, in their 5,500 brick-and-mortar stores as well as online. The brick-and-mortar is a reference to the fact that, while they are the 800-pound gorilla of their industry, the shift to online consumption (via game consoles, phones, PCs) has obviously been a major headwind for the chain. Think Blockbuster before Netflix.
The pandemic further crushed the stock, as initially consumers stayed away from stores and online game consumption took over. The stock was down to $2.80 in April last year. The company did well to stabilize, thanks to a hoard of $500 million cash on the balance sheet. Eventually, investors realized some tailwinds were coming: people shut in their houses were playing more games, stimulus checks were being mailed (to kids too!), and in December new Nintendo and Xbox consoles would hit the market. By the end of the year, the stock had recovered to $18.84. That said, the stock was as high as $50 just 5 years ago. The company is not expected to be profitable again until 2022.
Suddenly on January 11, the company brought in three new board members, one of whom was the founder of Chewy.com, the online pet product retailer, which has been successful. Thus began a trip for the stock from $20 on January 13 to $159 by midday yesterday, in only 8 ½ trading days. What happened? Retail investors happened, and they teamed up to run up the stock.
Perhaps you’ve heard that a lot of the gains in stocks last year came because “retail” investors (people investing their own money) finally started buying stocks again. The ingredients that came together to make it happen include: 1) stimulus checks, 2) Americans’ inability to spend money thanks to lockdowns, 3) stocks that are attractive to new investors (read: millennials) because they are technology-driven and have the potential to grow rapidly, and 4) the dubious proposition that these folks had excess time on their hands and (even more dubious) couldn’t gamble on sports because sports were canceled.
What started with a fascination for all things tech, but especially WFH (work-from-home) software stocks and Tesla, has morphed into two entirely new realms: 1) penny stocks (those with a very low price…usually companies nearly bankrupt or hardly even in existence anymore) and 2) heavily shorted stocks. Heavily shorted means that a lot of investors (usually hedge funds) are betting for the stock to fall. It is the opposite of owning a stock: they actually borrow shares of a stock from someone who owns them, then they sell them. When they want to close out the trade, they buy the shares and return the stock to the lender of the stock. Hopefully for them, the stock has dropped while they were short, because that’s how they profit. It’s a shady business, but it’s everyday business for hedge funds that strive for some form of “market neutrality,” meaning a fund will own stocks but also short stocks, and if the $ amounts of those two groups are equal, the fund is market neutral. So if the market goes up or down, it won’t matter to them…the only thing that matters is how the owned and shorted stocks perform.
So now we have set the stage. What happened prior to January 11 is that a lot of retail investors had been congregating on the Reddit (social media) site called r/WallStreetBets. That number is now 2.2 million, by the way. People share investing ideas on the site. Now what you should be wondering at this point is where “ideas” come from. How well-informed are these investors? Is inside information being shared? Are there dominant voices that people follow, and might this be fertile ground for pump-and-dump schemes? Pump-and-dump is when an investor accumulates a large position in a stock, then tells everyone to buy it, convincing them to do so usually with made-up information, like the company is about to sign a new business deal or get approval for a product. People then buy the stock, its price shoots up rapidly, and as the people are buying it hand-over-fist, who is selling the stock? The original pumper, who is now the dumper. The stock eventually collapses as demand from new buyers evaporates and the buyers turn into sellers on the way down.
This group wisely figured out that they could quickly pump a stock up if two conditions were met: 1) massive, coordinated buying by thousands of them, and 2) targeting stocks that are heavily shorted. GameStop (ticker GME) had already been targeted by January 11 as a result of its 140% short interest, which was the highest among all publicly-traded stocks. What is 140%? GME has roughly 70 million shares outstanding, but only 50 million “float” and are available for trading, because 20 million are held by insiders with trading restrictions. Out of the 50 million shares available, 71 million shares are being shorted. It almost doesn’t make sense how that many shares could have been borrowed and sold, but alas.
If this group was right and was able to ram the stock higher with shock and awe, they might be able to “shake the trees” loose of hedge funds who get scared and “cover” their shorts by buying the stock back, probably having lost money in the process. So, there would be massive retail buying, supplemented by hedge funds buying to cover their shorts…buying upon buying…a virtuous cycle.
And that’s exactly what happened; check out this intraday stock chart for GME over the last month. Stock price is the top line chart, trading volume is the bottom bar chart:
Notice how trading volume was relatively dormant until January 13, then suddenly shot up, along with the stock. Clearly, this was a coordinated plan. GME traded 144 million shares that day. Remember that only 50 million shares float. So, every share turned over an average of nearly 3 times…in 1 day.
The trade’s success attracted even more investors to throw money into it. Yesterday’s intraday high was more than double last Friday’s closing price, on volume of 177 million shares. The stock was halted 9 times yesterday for trading imbalances. You could make a good case that the later entrants to a trade are always the least-experienced and least-informed of traders. If you like a good anecdote, someone screenshotted this from the Reddit site last Friday, which quickly went viral if only because it demonstrates the level of sophistication among the investors:
So what should happen next, now that the stock has been pumped, the shorts bail out, the short position drops, and the buying interest subsides, is the stock goes back down, right? As it turns out, the short interest is still 71 million shares today (this is reported daily). Word on the street is that a lot of shorts did cover, but a lot of new shorts came into the stock, smelling blood if/when the stock eventually tanks. So, the battle rages on between the Redditers and the hedge funds.
For those of us on the sidelines, this is utterly riveting. There have been innumerable bubbles and pump-and-dump schemes in the history of the stock market, but none so well-coordinated and amidst electrified retail investor enthusiasm and social media congregation. We are in day 10 of this war, but there are now a lot of other very interesting battles underway.
Bespoke (a research firm) today published a list of the 15 most heavily-shorted stocks in the Russell 3000 as of the beginning of the year. I looked at the price chart of each of them; most have been “discovered” as “the next GME” and have shot up since January 1. Among them are a lot of other retailers, such as Bed, Bath & Beyond, Dillard’s, Macy’s, and some retail REITs. Also: Tootsie Roll, one of the most secretive stocks that is publicly traded. It is majority-owned by Ellen Gordon, CEO and Chairwoman, who took over the company when her husband Melvin passed away. She is 89 years old. The company hasn’t grown in years, which likely enticed investors to short 7 million of the 19 million floated shares. Lo and behold, the stock is up from $30 on Friday to $37 today.
We wish the Redditers well because the ultimate feeling of schadenfreude for us comes from shorts getting burned. Maybe it’s the patriot in us, maybe it’s because the hedge fund industry has suckered investors for way too long into believing they can magically create returns (which they haven’t) and then have the audacity to charge 2% and 20% of gains. However, we all know from history that if a country fights wars on too many fronts, the resources become insufficient eventually.
Amidst all of this action in their stock, GameStop management has remained surprisingly quiet. If this happened to Tesla (oh wait, it already has, multiple times), the company would have quickly issued $5 billion of new shares to dilute all their shareholders (oh wait, they did). If only we could Zoombomb GME’s board meetings…
As we mentioned earlier, heavily-shorted stocks are not the only ones attracting attention….penny stocks, the ultimate destination for speculators, are as well. These are similarly being pumped up through social media sites. The attraction is obvious: when a stock is priced in the pennies, its upside potential is exponential. There are dozens of examples, but we’ll take look at one, Zomedica, ticker ZOM. (No relation to Zoom). The stock was “discovered” on the first trading day of the year, when it leaped from $0.23 to $0.35. A week later, the stock was $1.30. The company has been working to develop a diagnostic product for veterinarians for years. There was no news other than the company named its interim CEO as CEO, and he apparently talked up the product. A week later, none other than Carole Baskin, of cult fame from the Netflix series “Tiger King,” created a video touting the product’s upcoming release in March. Shortly thereafter, it was rumored that she was paid $299 to pump the product, but it’s unclear who paid her. As its stock began to wane last week, the company announced the first vet customer for its product, which provides “a non-optical and fluorescence-free detection for use at the point of care…using Bulk Acoustic Wave technology.” We’ll refrain on rendering judgment on the validity of this product. So far, the stock is hanging around the $1 mark, trading over a billion shares on some days:
Our final fun observation today is the mania surrounding company names. Earlier in January, Elon Musk tweeted his love for a new messaging product called Signal. Naturally, retail investors took to the streets and bought up the stock of Signal Advance, ticker SIGL. The stock rose from $0.60 to $38.70 over the course of 3 days. Unfortunately, SIGL has nothing to do with the messaging app; this company instead is in the medical device business. Once this was realized, the stock naturally sank…but is still trading at $6 today!? That’s 10 times the price at which it had been trading for years. Just this morning Elon tweeted that he loves Etsy because he bought his dog an outfit on the online marketplace for homemade products. Etsy stock opened +8% today, although it has given back all those gains by late morning.
The narrative is that retail investors suddenly became aware that you can make money by owning stocks, and they suddenly had the time, the cash, and the zeal to “play” the market. Let it be known that millennials, as a generation, had heretofore not embraced the stock market for the entire bull market, after the financial crisis left them with scars from the impact on the economy and the market. We are glad they have rejoined. Apparently, compounding high single digit returns for decades to build wealth did not sound appealing, hence the need to swing for the fences.
What does this all mean for the rest of us? Speculation is generally an apt signal for risk-taking, and risk-taking typically hits its peak when the market hits its peak. One main reason for this is that buying begets buying…if people see other investors making profits, they tend to want to join in too. For investors who suddenly find it “easy” to make quick profits trading stocks, they tend to want to go to the next level in search of bigger, or quicker, riches. Hence, they push the level of speculation to new frontiers. Penny stocks are the final frontier in the stock market for speculation; almost always the underlying companies are barely operational, have no sales, no audited financial statements, and no fundamental basis for investing in them.
We have also been keeping a watchful eye on IPOs (initial public offerings) and SPACs, which are bought by investors speculating on the possible someday IPOs of unknown companies. We’ll save the SPAC 101 course for another blog post, but suffice it to say, it’s as zany as GameStop. And of course, every bubble needs a theme. While WFH software stocks have had their day in the sun, electric vehicles (EVs), alternative energy, and cryptocurrency (Bitcoin) have been consistent themes for the last few years. A real estate company over the weekend “rebranded” itself as an EV company; its stock popped 50% yesterday. Elon Musk is now the richest man in the world, even as his company is not even profitable on an operating basis.
You can probably hear what we say next a mile away. Keep your eyes on the long-term and let fundamental investing and compounding growth do the hard work for you. In the meantime, enjoy these interesting times!