“An Investment in knowledge pays the best interest”
“An Investment in knowledge pays the best interest”
30 Jan 2021by Aditya Anand Bapat
The beginning of CY2021 saw an unlikely contest between two non-equals in USA. A group of retail investors got together on a social media platform Reddit and took on hedge fund managers in stock of a struggling games and entertainment company called GameStop. All of this sounds rather ridiculous. How can puny retail investors take on mighty hedge fund managers and emerge victorious? Stock markets occasionally throw up such ridiculous contests and as always, this one too was driven by the most common market emotions – Greed and Fear.
As per Wikipedia, GameStop is an American video game, consumer electronics and gaming merchandise retailer. It is supposedly the world’s largest video game retailer with more than 5,500 stores throughout the US, Canada, Australia, New Zealand, and Europe. Despite its size and reach, GameStop had been struggling for some time as people chose to purchase games online during the pandemic rather than walk into stores. GameStop's share price had been languishing in single digit Dollar prices for the first nine months of CY2020 and in double digits below $20 since then. Even before the pandemic, GameStop’s revenues had slid for each of the year since CY2016. Profits too were on a declining trend and the company slipped into net losses in CY2019 and CY2020, as per data from website MarketWatch.
Till 12th January, 2021, GameStop’s share price remained below the $20 per share mark. A bunch of Hedge Funds had been building heavy shorts in its stock as they felt that the company’s fundamentals did not merit the price it was trading at. They wanted to make a killing when the price declined further and come out richer.
However, some users (retail investors) of social media website “Reddit” were discussing this same stock on the discussion thread “WallStreetBets”. They felt that the stock was trading too low and its valuations were inexpensive. They also felt that induction of Ryan Cohen on GameStop’s board would change the fortunes of the company.
Ryan owns nearly 12% stake in GameStop and was the former CEO of Chewy Inc., an online pet-food company. Hence, they started building long positions in the stock leading prices higher and higher each day. GameStop's share price rose from $76.79 on 25th January, 2021 (when the big action started) to a mind-boggling $325 on 29th January, 2021, return of 323% in four trading sessions. In fact, if you calculate the stock return in the current calendar year, it is a mind-numbing 1,784%!! That much money in 19 sessions flat!
As the price kept rising, hedge fund managers panicked and started unwinding their short positions, leading to further spike in GameStop share price. This is called as a short squeeze. Without getting too technical, a short squeeze is one where shorters cover their positions by buying the stock since it is rising. This has a domino effect and the stock rises even further due to due to buyers’ pressure. Other companies such as Blackberry, Nokia, AMC Entertainment also show such action, but the one in GameStop was most dramatic.
The fallout of the episode till now is that several hedge funds have incurred huge losses in their stock positions. Retail investors emerged victorious and richer. The press was filled with news articles about people amassing huge sums of money in a matter of few days. From a 10-year old boy making $3,200 on his $60 investment in the company to a top Indian fund manager’s son making a killing in the stock, GameStop had become the talk of the town.
The whole episode was hailed by some sections of the press as a victory of the tiny versus the mighty. After all, rarely have hedge funds been crushed by ordinary investors. This was a classic case of “Robinhooding” in the stock market – take money from the rich and give to the poor. Talking of Robinhood, there is a popular trading platform in the US by this name, set up by Indian American Bhanju Bhatt.
As GameStop share prices surged incessantly on US bourses, Robinhood stopped its clients from buying further shares of the company. It received a lot of flak from the general public and politicians for this decision. Some termed this as an end of “democratized” trading in the US. Others alleged that Robinhood succumbed to pressure from mighty fund managers who were suffering losses. It finally had to give in and trading in GameStop from the platform was restarted on Friday, 29th January, 2021.
The entire episode has many dimensions to it – rise of retail investors, role of social media in creating a mountain out of a molehill, a trading platform switching sides dramatically and many celebrities and some sections of the press hailing the retail investor as a winner. In our opinion, it is difficult to proclaim a clear cut winner in this case. However, we know the biggest loser for sure. It was Fundamental Analysis. No one bothered to study the company, its financials or management strategy before taking positions in the stock. All that they cared about was who took bigger positions and whose “long” or “short” was bigger.
A company could have strong fundamentals or may be a compelling turnaround story. However, nothing ever can define a 1000% plus up-move in a few trading sessions. Incidents such as these are rare and making money from them is even rarer. It is speculative, filled with vengeance and certainly dangerous. Over the longer term, it is only fundamental analysis, studying a stock in detail that multiplies wealth sustainably and safely. For more excitement and action, you can always head to a casino.
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