From GameStop to AMC, people across the country are suddenly becoming obsessed with “meme stocks.” But what really makes a meme stock valuable? How do we understand which to invest in and more importantly when? Let’s look at meme stocks together and gain a deeper understanding of the ‘hype’ and ‘FOMO’ (fear of missing out) of meme stocks in 2021.
What is a meme stock?
A meme stock is a stock that goes up unexpectedly after people online coordinate buying the stock in mass. This value increase has everything to do with the influence of conversations, particularly a high volume of people engaged in the conversation, and little to do with the company’s performance. The main platform that this has occurred on is Reddit, a popular site that serves as a forum where users can share news and interact with one another. A subreddit page known as WallStreetBets has recently fueled the fame of these stocks, particularly with GameStop (GME). This group of users began buying the stock in large quantities when they saw that a hedge fund had undervalued it, or “shorted” the stock.
What does it mean to short a stock?
1 – “Short-Seller” (hedge fund) borrows 10 shares of Stock X from a Broker.
2 – “Short-Seller” (hedge fund) sells 10 shares of Stock X to the market for $500
3 – Stock X loses value in the market, i.e., the price goes down
4 – “Short-Seller” (hedge fund) buys back 10 shares of Stock X for $400
5 – “Short-Seller” (hedge fund) returns 10 shares of Stock X to the Broker & keeps $100
The “Short-Seller” never owned Stock X in the first place. However, the “Short-Seller” gets to keep the $100 made between the sale/repurchase of the shares in the market. This technique is used by professional investors (hedge funds). It provides the opportunity to create large profits, but also to lose large sums of money.
How does a meme stock gain value?
When a “short-seller” (hedge fund) shorted the Game Stop stock, hoping to gain that “$100” when it lost value in the market, the WallStreetBets group had a different plan. They began buying the stock to increase the price. They then continued the conversation online to influence other users to buy, increasing the price as more people invested. Users like those posting on the WallStreetBets page take glee in tormenting short-sellers, especially the mainstream hedge fund managers. They can cause the short-sellers sufficient pain because they are forced to buy shares to undo their negative bets. This pushes the stock up even further, and at the same time instigates a form of economic rebellion against the perceived gluttony of the establishment investors. While this classic “short squeeze move” is not new, the cultural change is the introduction of the high volume of conversations that someone “putting on the squeeze” can now garner on the internet.
So how do you make money from a meme stock?
As the conversation continues, early investors like those on WallStreetBets begin selling their stock and seeing their profit. Other investors begin to see the price fall and start selling out to keep any possible profit. This becomes a chain reaction, and these stocks start to see an inevitable crash once the hype dissipates. It is imperative to know the risks of timing that come with investing in meme stocks. Many people that invest at the end of this process will see very little if any profit. The “short-seller” or hedge fund will likely not make any money from this stock because the meme stock buzz caused the price to increase rather than fall as they expected.
Why do conversations matter with meme stocks?
The value of meme stocks fluctuates based on what people say and believe about them, not because of the company’s performance. For example, In December of 2020, the cryptocurrency Dogecoin saw prices soar when Elon Musk tweeted, “One word: Doge.” It increased again in February of 2021 after he tweeted, “Dogecoin is the people’s crypto.” However, in May of 2021, Dogecoin tanked after Elon Musk participated in a skit on Saturday Night Live (SNL), calling the cryptocurrency “a hustle.” This proves that meme stocks are very risky and that conversations are at the center of the result. The phenomenon of meme stocks is very simple. It only works because of the influence of conversations and if a stock can garner enough mass of conversation and the action that correlates to those conversations. So, you see, talk is not cheap, it is now a currency of value moving hundreds of millions, at times billions, of dollars. “Like the nature of anything viral, if enough people engage in a conversation like it’s a truth, then it becomes a truth.” – Jon Kleinman, Partner at Insigniam.