June 26, 2021
Meme Stocks like GME, BB and AMC keep growing in popularity in the face of sound investment fundamentals. Here's what you need to know.
What do you get when you mix the desire to get rich quick, a communication platform that reaches thousands of people in an instant, zero fees on trades, money available due to increased savings during the pandemic (not everybody renovated their homes), fear-of-missing-out (FOMO) syndrome and the motivation to stick it to Wall Street? The meme stock phenomenon.
Meme stocks are quite recent, so much so that there is no specific definition. It is not part of the portfolio management curriculum. Even so, the phenomenon is very real. Meme stocks are stocks that see dramatic price movements irrespective of the company fundamentals. It is more within the realm of day-traders willing to speculate on price momentum. The sudden increase in trading volume seems to be fuelled by calls to action on certain social media platforms such as Reddit’s WallStreetBets who try and ruin short call contracts purchased by hedge funds, often referred to as “short squeezes”. Investments in meme stocks are highly speculative and volatile.
Generally speaking, successful investments come from buying stocks of profitable businesses that increase their revenue in order to reinvest in their future growth and generate free cash flow for the benefit of their shareholders. But what if someone told you to invest in a company that posts net losses with decreasing sales and no real prospects? Would you feel confident about making that investment? Investors that look at some basic fundamental measures would not. But fundamentals are not part of the meme stock DNA.
One of the first meme stocks that made headlines in 2021 is Gamestop Corp (GME), a video game and entertainment software retailer. This company has recorded net losses during the last few fiscal years with decreasing sales over that same period. Let’s have a look at its recent stock prices to give you a sense of how quickly it can move.
On January 12, 2021, GME’s stock traded slightly below $20 USD. Two weeks later (January 27th), it closed at around $347 USD. That’s a 1,635% increase over two weeks. Pretty exciting. And this is where the FOMO feeling kicks in. That voice in our heads that says: “If others can make that much money so easily in such short time, I want in too.” Here’s the thing though. Only three weeks after the peak, the stock was trading at around $41 USD. For those keeping score, that’s a drop of 88% from the January 27th high. Do you remember how you felt in early 2020 when the Canadian equity market dropped a little more than 30% over approximately one month? Multiply that feeling by three. This is just one example of the extreme volatility that can be associated with a meme stock.
At the time of writing this article, GME is trading around $210 USD and remains very volatile. It’s hard to imagine that the stock price will remain at these levels given the company’s fundamentals, but as long as the appetite is there to purchase the stock, it seems fundamentals are out the window. Such is the nature of a meme stock. Just remember how quickly it can come crashing down.
Meme stocks can certainly be exciting, but they can also be devastating depending on which side of the trade you find yourself. They should absolutely not be the basis of a sound financial plan. If you can’t resist the temptation of buying into the meme stock mania, make sure you don’t invest more than you are willing to lose.
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This writing is for general information purposes only and is not intended to provide legal, accounting, tax or personalized financial advice. If you are not sure how to proceed with a request for further information, seek help from a professional. Any opinions expressed are my own and may not necessarily reflect those of Louisbourg Investments.