Broker Check

Let Them Step on The Same Rake.

May 16, 2024

Poltergeist II was a towering contribution to pop culture thanks to one key phrase that continues to haunt us:

"They're baaaaack…"

The little girl said this about evil spirits invading her home, which was built on top of a cemetery, and it became the crux of the movie's marketing campaign. 

Fast forward to today, and there’s no better way to explain how I feel about meme stocks being back in the news. GameStop soared 74% on Monday, and on Tuesday, it was up 110% at one point. Trading volume was 30 times heavier than usual on Monday, and the stock halted nine times in the first 90 minutes of trading. Here’s Tuesday’s volume relative to comparably sized companies. Wow!

Don’t assume a stellar earnings report or Apple buying the company caused the fervor (they aren’t). It all started after a single tweet on X by Keith Gill, better known as “Roaring Kitty.” Yes, the same Roaring Kitty who ignited the first wave of meme stock madness in 2021, when GameStop exploded from $1 to $120 in six months. This was his first tweet in three years, and boy, was it a big one.

The subsequent media attention has rekindled interest in “meme stocks,” so let’s explain what they are and why the world has become fixated on them once again.

What is a meme stock?

A meme stock combines widespread retail investor attention and participation with a massive disconnect between price and fundamentals. The key delineator between a normal stock and a meme stock is that expectations for future earnings drive the former, while hype and Fear of Missing Out, or FOMO, drive the latter.

They get their namesake from the memes posted all over social media after the attention to them explodes.

How does a stock become a meme stock?

Most meme stocks have one or more of the following in common:

  • An iconic brand or well-known company that has been around for a while but also fallen to the wayside.
  • Lots of institutional investors like hedge funds are betting against the stock (aka a large “short interest”).
  • A catalyst sparks interest, such as bankruptcy (Hertz), restructuring (AMC), misinterpreting an Elon Musk tweet (Signal Advance3), etc.
  • Something funny that traders can rally around, like the stock NAKD that surged from less than $1 to $3.40 in a matter of days3.

GameStop was the most heavily shorted stock of its size in 2020. Meaning, so many investors were betting that it would fall that any positive news or movement in the stock could ignite a short squeeze. This happens because short sellers have unlimited risk if the stock rises. If it does start to move higher, short sellers frantically buy to get out of the trade, throwing gasoline on the ensuing bonfire.

Roaring Kitty became the catalyst for the GameStop short squeeze by sending letters to prominent market strategists, creating a YouTube channel, and leveraging a Reddit chatroom to convince others to buy in. 

What does it mean for the business?

This is where it gets funny for investors who don’t buy meme stocks. Back in 2021, most meme companies were fighting to stay alive. AMC owned movie theaters that were illegal to attend, Bed, Bath, and Beyond was fighting off bankruptcy, and GameStop owned brick-and-mortar stores in an era when game purchases were moving online.

But with this newfound interest in their stocks, management teams did what any rational leadership would do – they issued more shares. It was the ultimate lottery ticket, and they cashed in big time at the expense of Reddit-fueled insanity.

I’d wager that some of today’s meme companies will do the same. AMC already did this on Tuesday to pay down expensive debt5.

Which stocks could be next?

I have no idea. Finding the next “haha, this stock ticker is pronounced ‘naked’” requires a skill set that I and most other institutional investors proudly lack. Instead, I’ll keep looking for companies that can grow cash flow and leave the Beavis and Butthead approach to far more capable traders.

Is this legal?

It’s hard to say. There’s no shot the Securities and Exchange Commission (SEC) is happy about any of this, but I’m not sure there’s much they can do about it, either.

For example, here’s the meme that Roaring Kitty posted this week. It’s just a guy sitting in a chair with a videogame controller leaning forward4. I’m no lawyer, but how this is evidence of stock manipulation is beyond me.

Are we missing out?

Sir Isaac Newton was an investor in the South Sea Company in the early 1700s. After cashing in on early gains, he got back in at the height of the bubble and lost big in the crash. After the bubble burst and chaos ensued, Newton purportedly claimed, “I can calculate the movement of stars, but not the madness of men.”

Over the long run, stocks rise because expectations for higher revenue, earnings, and/or cash flow are met. In the short term, stock prices are influenced more by fear, panic, greed, and euphoria.

The challenge is that these emotions are unpredictable. No Excel spreadsheet can discount human behavior the same way it can cash flows. Therefore, if you want to get in on this action, only bet what you’re willing to watch go to zero because there’s a good chance that history will repeat itself (per the chart below).

Should we be worried?

Despite the media attention, meme stocks have failed to garner much demand outside chatrooms. But just in case, let’s examine the data to look for signs of a potential bubble forming by comparing it to the greatest bubble of our generation – the dot-com crash.

In April 2000, right around the time the bubble burst, here are just a few of the companies that were trading at valuations that look like typos6:

  • Terra Networks: 1,200x sales
  • Akamai Technologies: 3,700x sales
  • Telocity: 5,200x sales

Here are some of the more notable meme stocks as of May 15th:

  • GameStop: 2.0x sales
  • AMC: 0.2x sales
  • Tupperware: 07x sales

Furthermore, the combined size of all these meme stocks is a few billion. Compare that to the roughly $50 trillion in market cap across all U.S. exchanges, and this is, at best, a rounding error. The media hype just makes it feel bigger than it really is.

Simply put, this is not 2000 or any other bubble. It’s not even close. So, if the FOMO crowd wants to go again, then have at it. I’ll gladly sit on the sidelines and watch them step on the same rake.

The bottom line

Books will be written about meme stocks, and classes will be taught at top business schools for decades. They already released a movie about Roaring Kitty and GameStop, appropriately titled Dumb Money.

Professors will opine what caused this to happen in an age when investment education has never been more readily available. But the roots of mania lie in human behavior, and nothing will alter the madness of people. Rich or poor, smart or dumb, it doesn’t matter. We are all hardwired to feel the rush of victory and the agony of defeat. Some can just control these urges better than others.

The bottom line is that there is no canary in the coal mine. This is a fad, and like every other investment fad, it won’t last.


 


Sources

1 https://www.investopedia.com/who-is-michael-burry-5235600

2 https://financhill.com/blog/investing/what-happened-to-nakd-stock

3 https://finance.yahoo.com/news/elon-musk-tweet-sends-this-stock-up-1500-in-24-hours-may-be-a-sign-of-market-bubble-175845075.html

4 https://twitter.com/TheRoaringKitty/status/1789807772542067105

5 https://www.sec.gov/ix?doc=/Archives/edgar/data/0001411579/000110465924061550/tm2414552d1_8k.htm

6 Bernstein, William. The Four Pillars of Investing. 2003. Print.

 

Disclosures

This material has been prepared for informational purposes only and should not be construed as a solicitation to effect, or attempt to effect, either transactions in securities or the rendering of personalized investment advice. This material is not intended to provide, and should not be relied on for tax, legal, investment, accounting, or other financial advice. You should consult your own tax, legal, financial, and accounting advisors before engaging in any transaction. Asset allocation and diversification do not guarantee a profit or protect against a loss. All references to potential future developments or outcomes are strictly the views and opinions of Richard W. Paul & Associates and in no way promise, guarantee, or seek to predict with any certainty what may or may not occur in various economies and investment markets. Past performance is not necessarily indicative of future performance.