When mainstream news covers the stock market it’s usually how the major indices performed that day, significant drops or all-time highs, or if something political moved the market. Recently, we saw something new: The story of GameStop and a Reddit forum group called WallStreetBets.
To summarize, a hedge fund manager decided to bet against GameStop, a video game, consumer electronics, and collectibles retailer. The hedge fund practiced short selling, a common practice where shares are borrowed from other holders and sold by the hedge fund manager. Except for the size of their short bet, this was pretty insignificant, until users of Reddit, a social news forum and discussion website, decided to buy shares of GameStop.
When an institutional investor spends hundreds of thousands of dollars to drive up the price of a stock, that can be considered market manipulation. However, this was hundreds of thousands of individual investors purchasing a few shares of stock each. The result was the same—GameStop’s price went from just under $20 to more than $347 in 11 trading days. Investors who shorted the stock were forced to buy the stock at more than 17 times the original price, which created huge losses for hedge funds who shorted millions of shares.
Some individual investors made a lot of money in what was intended as a “middle finger to The Man.” Of course, by the time the average investor heard about GameStop’s meteoric rise, it was far too late to profit from the event. However, that doesn’t stop investors from asking their financial advisers, “Why don’t you take advantage of these market opportunities?”
The simple reason is that financial advisers are paid to manage, grow, and protect your wealth, not gamble or speculate. This fad was far too much risk exposure for retirement funds. Social media influence on the stock market is not indicative of a move away from fundamentals. Generally, investors are looking for a future cash flow, whether that comes from a business venture, stock ownership, or real estate. If an investment is promising a high return, consider the risk taken to achieve that attractive return. I recommend investors use strict investment criteria that begin with financial strength and safety. The company should be a leader among its peers and be poised to provide long-term growth and value. Drilling down further, look at the company’s financials, business risk, strength of management, and competitive advantage. You want to select stocks that will not only weather the next recession but the next depression. Looking back at 2020, investors should realize that anything can happen.
Ask yourself, “If the investment promises to grow my money tenfold, how great are my chances to lose money?” If you can’t afford to lose money, then this type of investment isn’t for you. Furthermore, if you cannot understand how your investment makes money, chances are you are not the one who will profit. Fundamental analysis of a company’s financial positions and performance, the market in which it operates, competitors, and the economy has been around for more than 80 years. It dates back to the economist, professor, and investor Benjamin Graham whose books taught Warren Buffett to invest.
Investors are irrational, and the markets are efficient, at least in the long run. Those who took a chance on GameStop when it was skyrocketing may still be holding a stock that is selling for around $50 today. As with any company with a shady history, weak fundamentals, and a new leader with a history of success, it is very likely that the price will reflect its true value as it becomes more apparent in the future. Until then, GameStop will remain an industry joke among conservative investors, and I’ll continue to focus on company fundamentals.