Insights
GameStop is up 2,000% - Tulips in 2021!
January 29, 2021
GameStop does not have a vaccine for Covid, nor has it created software that magically makes our lives better in some way. It is a chain of 5,000+ stores that sell new and used video games. The company is a year older than Blockbuster, and almost as useless in today’s world where it is easier to purchase games over the internet.
The business was losing money even before the pandemic hit. Last September, GameStop announced plans to close 450 stores. The shares were trading at $7 then, having steadily declined as profits shriveled up over the previous five years. Then the founder of pet product retailer Chewy purchased 12% of the shares and a partnership with Microsoft was announced. The concept of a new GameStop that delivers “rich new digital experiences” to customers and becomes the “ultimate gaming destination” helped the share price reach $20 by December.
On January 13th, 144 million shares traded, more than ten times the normal volume. The last ten trading days have been wild – the share price reached $483 this morning, more than 20 times where it started the year. This makes little sense – but it parallels past market manias that offer captivating stories. This time it is a David-and-Goliath battle between an army of small investors and a handful of Wall Street hedge funds, never recipients of much sympathy.
Why GameStop? At the end of 2020, about 70 million shares had been sold short. That is more than 130% of the 52 million shares available for trading (known as the float), an insane ratio. It was the most shorted stock on the market, and it looked like a cheap bet to speculators.
Shorting a stock is risky. It involves borrowing a company’s shares and selling them with the intention of buying them back cheaper when the share price falls. If the price doesn’t fall, the losses can be huge. The hedge fund shorts were complacent and are now paying a heavy price for lacking protection from being squeezed.
Speculation has been with us for hundreds of years. Tulips (1637), sketchy overseas trading operations (1720) and Cabbage Patch Kids (1983) are a few of examples of speculative bubbles that captured imaginations and attracted many investors before they collapsed, leaving many losers and a few winners in their wake.
There are historical bubble patterns that are observable now. First, the past year has been one of heightened uncertainty, one where extreme views could gain a surprising number of adherents. Second, a story has emerged that “explains” why the scheme is working. That a loose confederation of day traders is managing to smack around some big-money investment firms makes for good reading, and skeptics are not welcome. Third, the speculators have “play money” at their disposal.
Other notable factors that added gasoline to the fire:
- Zero commissions encourage active trading.
- The Robinhood trading app is anonymous. No need to talk to a broker – just click to trade.
- Traders are communicating via internet forum known as WallStreetBets at reddit.
- “Forgotten” stocks like GameStop, Koss (headphones), Tootsie Roll and AMC Entertainment (movie chains) encounter less selling when the action starts.
- Over the last year, retail traders have embraced the use of options to make leveraged bets on individual stocks, which helps explain the meteoric rises.
Observations
- Bubbles defy prediction – only afterwards does everyone nod their heads and say, “of course…”
- Lost in the hubbub is the potential valuation of GameStop’s actual business. A profitable UK-listed peer stock that we follow is valued at about one-sixth of annual sales. By that admittedly crude reckoning, Gamestop might be worth about $10 a share.
- Bubble stocks eventually return to intrinsic value. At the height of tulipmania, the rarest bulbs traded as high as six times the average person's annual salary. Within a year, prices had “round-tripped.”
- Wherever GameStop lands, the only real consequences will be a transfer of wealth from losers to winners. It is a zero-sum game.
