This was a wild week for Wall Street. I didn’t want to write on the GameStop short squeeze this week, but it’s really hard to divert my attention from what’s unfolding.
In order to purge my brain from the onslaught of news, I thought I would write down my general thoughts and opinions of the situation. I will break down what I think are the Good, Bad, and Ugly aspects of the short squeeze, and how I think this may affect value investors going forward.
I won’t summarize the situation, since hundreds of other outlets have already. See the links below for reference.
Let’s start with the Good.
If anything, this week has been entertaining. To see a company’s stock like GameStop, (which has been in decline for years now) rally this much with only retail investors, is staggering.
Browsing the comments on Wall Street Bets is a wild ride. What is interesting is most of the posts regarding this situation have nothing to do with the value of GameStock as a company, but rather are speculative and political.
This is not really a surprise, as most people view WSB as a place for rampant speculation and stock market degenerates. No doubt about it, they exist on the thread, but it’s also unfair to lump all these investors together under one roof.
Checks and Balances
In the last couple decades, investing has become far more democratic than ever. With the rise of the internet, social media, investing research platforms, and investing apps, access to Wall Street has never been easier.
Hedge Funds and stock market “experts” are becoming far less relevant. The unknowns of the markets are becoming common knowledge. It’s easy to track your favorite stocks, business professionals, and even hedge funds. 13F filings are available at a moments notice, revealing the hedge fund’s holdings and strategy.
Acquiring this information used to be far more difficult and tedious; if you could even acquire it!
As we have seen, retail investors are far more powerful than previously believed. As mentioned before, I believe that this is partially true because of the rise of investing apps like Robinhood. Take a look at the growth of its user base.
This easy market access has allowed investors to be more in tune with Wall Street. All it takes is a few taps on your phone.
This democratization of information and access has given retail investors power. Groupthink is powerful when concentrated. For better or worse, it has held the seemingly untouchable Wall Street elite accountable. Better yet, made them scared.
I think a world where more institutional checks and balances exist is not a bad thing.
Speaking of Bad…
The Bubble Will Pop
Nobody is going to make it out unscathed. Melvin Capital and other hedge funds have already felt the pain. Money will be lost; on both sides.
I can’t really think of many situations where a company’s value increases over 1,000% in less than a week. GameStop stock is seeing a lot of price action, with no fundamental change in the business. This is classic bubble territory.
Sooner or later, the fundamentals of the company will prevail, and the stock price will revert to the mean. I don’t think many investors (including myself) truly believe that GameStop is worth its current price of over $300 per share.
Therefore, the stock price will crash. This could be tomorrow, or in a year. Nobody knows how long the groupthink will last. Eventually, investors will get nervous and start taking profits.
Those who bought at the top will feel the pain.
GameStop: The Real Loser
Over the past few years, GameStop executives have been looking to sell the company. They finally stopped in 2019 when nobody showed interest in buying a dying business.
If GameStop’s stock price remains high for the foreseeable future, then it will undoubtedly run the company into the ground. If another company was interested in buying GameStop at ~$10 per share, they certainly won’t be willing to buy it for over $300.
I don’t think this is a major pain for GameStop, since there were no interested buyers. However, other companies (like AMC) had some serious acquisition contenders recently. Those companies will most definitely walk away while the stock price is high.
Now for the Ugly…
SEC/Government Gets Involved
The news has been so loud this week, that the SEC would have been deaf not to hear it. It was also loud enough that it reached the floors of Congress. Politicians from both parties have voiced their opinions on the matter.
Funny enough, the GameStop debacle is now a bi-partisan issue. Since Robinhood halted the trading of GameStop, politicians from both sides of the aisle came to the defense of retail investors.
Whatever your political alignment, I think most of us can agree the fact that the Federal government has its attention on the stock market is probably not a good thing. Whether WSB is practicing market manipulation remains to be seen.
Regardless, it’s highly likely that the SEC will step in at some point, especially if things continue to get out of control. Whether right or wrong, we now face risk of increased legislation on Wall Street.
The Stock Market Casino
Let’s face it, most ordinary people don’t understand how the stock market works. To be fair, it takes some education to understand. You can get a PH.D. in finance and still not completely understand how the stock market works.
A lot of people think that the stock market is akin to gambling, or synonymous with a casino. When they see things like this in the news, I think this only reaffirms their beliefs. Right now, the market is filled with speculation, with some people actually becoming very rich, very fast.
All of a sudden, everyone becomes interested in the market. It’s hard to watch your neighbors get rich overnight. People might jump on the bandwagon only to immediately get kicked off and break a leg.
Essentially, I think this sets some dangerous precedents for people to make some terrible behavioral finance decisions. Some people will download an app, buy a stock with all their savings, all because someone else made 1,000% in a week.
This is a mental minefield for some people. Yes, the stock market can make you rich quick as we have seen, but these events are outliers in a normal market cycle. It’s not normal. By all means, if you want to gamble, please go to a casino where you can have some fun.
The stock market is not a safe place to get rich fast, but a safe place to get rich slow.
What Does This Mean For Value Investors?
The Value of a Business
For value investors, the GameStop short squeeze doesn’t change anything. Simply sticking to Warren Buffett’s core principles and staying away from rapid speculation will likely have spared you from this situation.
As mentioned above, GameStop is not worth over $300 per share. Proper valuation will show this as fact. Buying in now is buying purley into hype. That method is proven to not work out well.
If you bought into GameStop as a value play prior to this week, then you would have set a price target and made a nice profit. That’s all there is to it.
I think that this is an important lesson for hedge funds and Wall Street “experts”. Not everything they do is as secretive as it was, and retail investors have more power than ever, especially when unified.
While entertaining, I tend to see this more as a negative event more than a positive. I understand that most people don’t trust the establishment, and revel in “sticking it to the man”. I get it. It can be fun to see rich people lose money.
However, I don’t like to see anyone lose money, unless it was gained illegally or immorally. Some people view hedge funds shorting stocks as immoral, but I don’t. It’s just a big risk, and this time it backfired.
But it’s not going to just be hedge funds that lose money. A lot of retail investors will lose money when this settles down. I don’t think that is a good thing, given our current economic situation.
Also, we now have to worry about more regulation. It remains to be seen who will get regulated and how it will be regulated. But I sure don’t want more.
Whatever the case, as long as we stay true to our value investing principles, value investors have nothing to fear.