What is meme stock investing?
Even if you don’t care about stocks, you must have heard of the buzzword “meme stocks”. Do you wonder why these stocks have become so popular? How are they different from other stocks?
We will explain in this article how meme stocks operate and how they perform in comparison to FAANG stocks. “FAANG” is the acronym that represents the stocks of the five top U.S. technology companies: Facebook, Amazon, Apple, Netflix and Google, a subsidiary of Alphabet. These stocks represent 15% of the S&P 500 and their performance has a substantial effect on the overall market. Now, let’s come back and try to understand the mania around meme stocks.
Meme is an image, video, text, typically funny and amusing in nature, that goes viral among internet users, often with slight variations. The term meme was not originated online. It was published in “The Selfish Gene”, a book authored by Richard Dawkins, where he used meme to describe an idea or behavior that spreads across people in a culture.
The virality of meme stocks happen in a similar fashion and hence the name. Meme stocks’ prices increase solely due to social media interest and not based on any fundamental value. Social media platforms like Reddit, Stocktwits, and Twitter, contributed massively to such artificial escalation. This meme stock frenzy is particularly driven by young investors with high appetite for risk, gaming, and social interactions. The combination of the right psychographics in the right social settings has fueled the unreasonable hike in prices in a short period of time, naturally, followed by an inevitable fall.
One of the most hyped meme stocks were GameStop (GME). For the past few years, GME, a video gaming and consumer electronics retailer experienced financial hardship, and had a rocky time particularly during the pandemic. Its share price plummeted from $30 in Jul 2016 to $18 in Dec 2020. Suddenly, in the beginning of January 2021, some retail investors on wallstreetbets, a Redditt forum, encouraged each other to buy this stock causing its value to skyrocket. In matter of days, its share price peaked to $347, 1900% up, on Jan 25, 2021.
When GME share price started soaring, the short-sellers began to lose a lot of money, which resulted in a ‘short squeeze’, effectively pushing the price of the stock up even further. On Jan 28, the stock hit an all-time high of $483. Now you must be wondering how short selling and short squeezing impact the meme stocks. Let’s understand it here.
Short selling is a trading strategy, where investors sell stocks they’ve borrowed in hopes of buying them back later for less, as they expect the price of the stock to fall. These short sellers are usually the hedge funds or other institutional investors, who borrow the shares from their broker. They believe that the stock is overvalued and will eventually plummet. The profit earned by these hedge funds is the difference between the selling and the buying price. However, if contrary to their expectations, the share price starts increasing , then these investors need to act fast to limit their losses since short sales have an expiration date. In an event of a continuous price increase, the short seller position gets squeezed as there are more retail investors buying the stocks and other short sellers are exiting and closing their bets. To exit their position, these short sellers start buying the stocks, which pushes the price further higher. This unexpected increase in stock price is called short squeeze that hits the short sellers particularly hard, as they might end up spending more money to rebuy and return the borrowed stock.
According to a data from S3 Partners, short-selling hedge funds suffered a mark-to-market loss of ~$20 billion in Jan 2021 in GME. One of the hedge fund Melvin Capital, which heavily invested in short selling stocks, including GME, lost 53% of its value during January. This explains it quite well why there is always a tussle between short-sellers and meme stock investors, who wish to capitalize on rising prices. Generally, meme stock investors have a negative perception of short sellers as the entire concept of betting that the company’s stock will decline, and in some cases spreading negative news to effect the decline. As described by NASDAQ, meme stocks are triggered by small traders who cause a short squeeze on the stock.
Another interesting fact about GME was its short interest to float ratio that stood at 114% in mid-Jan 2021, according to IHS Markit Ltd. What does this indicate? In general, short interest as a percentage of float above 20% is considered extremely high, indicating widespread negative sentiment about the stock. Additionally, these stocks are very volatile and often signal a potential short squeeze. The traders usually target such stocks, as the short sellers’ move to purchase the shares and close their positions can translate into much higher prices.
Other meme stocks that grabbed the headlines are AMC and Blackberry. With distressed financials in the past, they both went viral in 2021, on Reddit forum. While BlackBerry’s stock is 86% up from the start of 2021, AMC increased by almost 2820%. Some other prominent names in this category include Bed Bath & Beyond, Koss Corporation, Nokia, Sundial Growers.
Meme stocks follow a community-driven approach to investing but how does their life cycle work:
· Early Adopter Phase: A handful of investors observe a particular stock is deeply short sold and begin to buy it in bulk. The stock’s price slowly begins to climb, which is certainly the ideal time to get in.
· Middle Phase: Other people notice the increase in volume and more individuals start buying. As a result, the stock price skyrockets. At this point of time, there is a risk involved but you can still be a part of the frenzy.
· Late/FOMO Phase: Online conversations about the stock spread across the internet. At this point of time, fear of missing out, commonly referred as FOMO takes hold, and more investors join in.
· Profit-Taking Phase: Early adopters begin cashing out. People start fearing to lose money and sell too. Hence, the price goes down.
By now, you have learned about the concept of meme stocks and how unscientific it is. However, it is surprising to see their price performance compared to those of prominent technology companies. To analyze the same, a comparison of the year-to-date returns of five popular meme stocks with FAANG stocks and the overall market return. Here is the summary:
As evident and astonishing as it is, the meme stocks have performed over 55 times better than FAANG stocks and the market in general. This average return is particularly skewed by AMC and GME stock prices that have experienced a surge of 2820% and 1141%, respectively. This data demonstrates how the prices of meme stocks are pumped artificially and stay remote from the general market expectations.
Meme investing has brought a new revolution and gained popularity among young investors. Some see it as risky and can erode your entire investment because of the surreal increase in prices, predominantly influenced by viral interactions, followed by inevitable crashes. Others see it as a way to democratize investing and give a chance to youth to experience investing and capital markets and learn from it because time is on their side.
Authored by Ekta Bhatia for Finquisitiv
