A Collection of Loosely Related Thoughts on GameStop
Better to learn vicariously than experientially.
Well, GameStop is back in the news. I write that sentence with something of a resigned sigh. I had hoped we were past all that craziness. Alas, it would seem not. For the vast majority of us, this is something of little consequence to be safely ignored. For those of us who write about finance, however, this is a tremendous opportunity. There is much to learn from these examples of market zaniness. What follows is a collection of loosely related thoughts toward that very end. Better to educate ourselves vicariously than experientially.
First, some background. GameStop is a bricks-and-mortar retailer selling video game systems, software and accessories and a wide range of collectibles. Its business has been under considerable competitive pressure for some time, increasingly from online retailers and, most recently, digital software downloads. Revenue has not grown consistently since 2012 and the company is no longer profitable. Up until early 2021, its share price reflected this fundamental reality, declining 93%, from $14.40 in November 2013 to roughly $1.00 in mid-2020.
In January 2021, however, GameStop became the most prominent “meme stock” and saw its share price momentarily skyrocket to $483 during a short squeeze instigated by retail traders over social media. I won’t go into all the detail here. If you’re curious, the Wikipedia page is very thorough. Nevertheless, it was all a big deal at the time. Fines were levied. People were fired. Books were written. Movies were made. Congressional hearings were held. And then things quieted down. Keith Gill, the chief protagonist of the saga, disappeared from social media.
On May 12th, however, GameStop leapt back into the headlines. Mr. Gill posted a wordless meme, not even referencing GameStop, to his X (née Twitter) account. Naturally, this was enough to send shares soaring almost 180%. In one day. On June 6th, Mr. Gill announced a live stream to be held the following day. Shares climbed almost 50% in response.
If you haven’t figured it out by now, crazy stuff happens all the time in financial markets. Most recently, all it took was a picture of a dog, posted by Mr. Gill of course, to send shares in Chewy, Petco and PetMed Express sharply higher. Let me repeat that. A picture of a dog momentarily created over $4.5b of value. I like to say that investing is as much social and psychological as it is financial. This is the social element at work. These share price movements have nothing to do with the underlying business. They are entirely predicated on people seeking to profit from what they think other people will do. This kind of behavior, in varying forms to varying degrees, is far more prevalent than you would think.
These social interactions in the market influence the price of a share, an observable fact. But shares also represent a fractional ownership of the underlying business, the value of which can only be estimated and is independent of the share price. At any given time, the share price can be greater than, less than or equal to its estimated value.
Share prices are typically set by investor sentiment, the whims and fancies of the marginal buyer and seller. Sometimes such behavior is speculative in nature. Value, to the contrary, is based on a thorough analysis of the fundamentals, the actual and expected cash flows of the underlying business. In the short term, sentiment and speculation can have an outsized impact on a stock’s price. In the long term, however, considered investment decisions based on the fundamentals eventually prevail.
Disequilibrium between price and value can persist for quite some time though. These excesses can present great danger to those who aren’t careful but also, in due time, great opportunity for those who are. Sell when speculators have bid up share prices beyond the underlying business value and buy after prices eventually come crashing down to earth. Buy when short-term investors have artificially depressed the share price and sell when the price rises to better reflect the long-term value. For the purposes of protecting and building wealth, investment decisions are best made primarily on price in relation to value rather than solely on price in relation to a hoped-for future price.
The short-term volatility created by this type of market behavior perfectly illustrates why equities should be at the bottom of your asset allocation stack. By structuring your assets to invest for the long term, short-term gyrations in share prices, which are driven by volatile forces in ways too difficult to understand, can safely be ignored. Structured improperly, you could suffer dearly and needlessly if forced to sell for liquidity reasons at the wrong time. Structured properly, you are free to sit tight and capture the higher expected return over time that comes from holding more volatile assets. You need act only when you choose to, consistent with achieving your goals, rather than when circumstances dictate.
Comparison with others, a desire for conformity and the fear of missing out all ensure that social factors will always create volatility. Those who endeavor to protect and build wealth, however, must always keep in mind that such impulses are predicated on an ephemeral and illusory reality. We only read news stories about the winners. This skews our perspective and we overestimate our prospects for success. Often there are far more losers with far greater losses in aggregate.
Recall it is the marginal, or most recent, trade, often encompassing just a tiny, tiny fraction of the total shares outstanding, that sets the price for all the shares. We discussed this dynamic at length when learning from Vinfast last September. It is literally impossible for everyone to sell their GME shares at the intraday high of $483. The fantastical net worth of others at that price that you read about was never real.
Investing primarily from a social perspective is a dangerous game to play. You have to get the timing right twice, when you buy and when you sell. Then you need to do this successfully again and again and again over time. Leverage is typically employed as well to magnify the hoped for influence on others and ensure that when you win, you win big. It also ensures that when you lose, you lose everything. You must pay very close attention to your downside if you play this type of game.
From our perspective, leverage should generally be avoided. It is more important to protect, then grow, your capital. Small gains, if sustained and compounded over time, can produce tremendous long-term returns.
Social forces are ever present in financial markets and can be powerful. They can propel share prices far above (or below) the value of the underlying business and sustain that discrepancy for some time. Protecting and building wealth requires making investment decisions with this value always in mind. By placing equities at the bottom of your asset allocation stack, you are able to turn this volatility from a risk into an opportunity. These forces are a part of human nature, but we must put them in the proper perspective to resist and remain focused on achieving our long-term goals. While market zaniness is certainly entertaining, it is a risky game to play. Protecting and building wealth is best accomplished slowly and unspectacularly.
Thoughts? I would love to hear them. Email me at investmentinsights@zuckermaninvestmentgroup.com.
Written By Keith R. Schicker, CFA