Unless you’ve been hiding under a rock for the past two weeks (late Jan. – early Feb. 2021), not encountering any news whatsoever, you’ve surely heard GameStop mentioned more than a few times in relation to the stock market. In quick succession, GameStop’s stock skyrocketed in price only to come plummeting back down closer to reality.
What happened? Should it matter to you, the prudent long-term investor?
What happened is kind of complicated. And no, it doesn’t really matter to you. Let’s dig in a little deeper on both fronts.
What Happened with GameStop Stock?
I’m going to do my best to keep this as simplified as possible.
GameStop was a declining company that many Wall Street firms were convinced was headed for bankruptcy. And as such, for a long time, its stock price reflected that sentiment.
For example, on Aug. 15, 2019, GameStop’s stock price closed at $3.21 per share. On Dec. 24, 2007, it had closed at $62.30 per share. GameStop was on a downward trajectory.
Because so many on Wall Street were certain GameStop would ultimately go bankrupt, they had shorted an absurd percentage of the company’s stock. Again, I’m going to keep things simple here.
“Shorting” a company’s stock is essentially borrowing shares of a stock (and paying interest on them) and selling the shares immediately because you believe the price of the stock will decline. That way, when it’s time to return the shares you borrowed, you buy them at the much cheaper price, return them, and keep the difference in the price.
However, shorting a stock does come with risks. If the price of the stock rapidly goes up instead, you have no choice but to the buy back the shares at whatever the market price is in order to return the shares you borrowed. In a situation like this, if you shorted the stock, you will lose money. If the stock’s price rises rapidly and keeps rising, you will lose a lot of money by remaining in your short position.
A group of individual investors (more like “speculators,” honestly) on an Internet subreddit called “WallStreetBets” figured out that the percentage of GameStop’s stock that had been shorted was absurdly high. As such, they knew that if they could collectively cause a quick surge in the price of GameStop’s stock by buying a large number of shares, it would begin a chain reaction known in the investing world as a “short squeeze.”
In a short squeeze, the price spikes higher and higher in rapid succession, as those who shorted the stock scramble to buy back the borrowed shares before the price continues to rise further. This then feeds upon itself, causing the price of the stock to rise rapidly in a very short amount of time.
As you no doubt know by now, the idea regarding GameStop worked. The WallStreetBets crowd did indeed cause a short squeeze (or at least the start of one) and the price of GameStop’s stock took off.
On Jan. 4, 2021, the stock closed at $17.25 per share. On Jan. 27, 2021, the stock closed at $347.51 per share. Wow.
Now was GameStop as a company actually worth $347.51 per share on Jan. 27? Of course not. The business fundamentals of the company didn’t come anywhere close to matching that valuation. But the short squeeze was on, and short positions on GameStop were running for the exits, driving the share price ever higher.
If you’ve been following the news, you know that since that time, the share price for GameStop has fallen precipitously. Most of those who held short positions in GameStop have now repositioned themselves, and the stock is moving ever closer to a true valuation of the company.
In the midst of all of this, you’ve probably heard some stories, though: stories of some individuals who made very large sums of money by buying the stock when it was priced very low and selling those shares near the top of the dramatic price increase. Some of these individuals even made millions of dollars.
However, others did not fare so well. Some bought shares near the top, and as the share price has since plummeted, these individuals have lost a lot of money. For them, GameStop was a very bad trade. They bought high and since then have sold low.
On each side of this (making money on GameStop/losing money on GameStop), you had multiple individuals engaging in reckless behavior. There are many stories of people doing things like buying the stock with their rent money, buying the stock with their full paychecks, taking out loans to buy the stock, cashing out their 401ks to buy the stock, buying the stock with the full balance of their Roth IRAs, etc.
Some of these people got “lucky,” as it were, and made a lot of money. Many others lost a lot of money. Money they could not afford to lose.
I sincerely hope that none of my readers were reckless with GameStop, on either side.
Why the GameStop Mania Shouldn’t Matter to You
But if you were on the sidelines of all of this, not participating in GameStop stock either way, should any of this matter? If you’re someone who faithfully makes monthly contributions to your retirement savings and prudently invests them for the long term, should you feel like you missed out on something?
No, you shouldn’t. Why?
Because the GameStop mania was speculation, not investing.
You might remember an earlier blog post in which I described the difference between investing and speculation. Going into GameStop stock in the middle of the frenzy? Speculation.
The underlying fundamentals of GameStop as a company did not match the valuation that could be calculated from the astronomical share prices reached during the mania. The price per share was artificially inflated, as it were, by the dollars that kept pouring in on the buy side of the trades.
How do you explain a company’s share price going from $20.42 per share to an all-time intraday high of $483.00 per share in a matter of a mere 15 days? You can’t, based on fundamentals. You can, based on speculation.
Again, friends, as I’ve stated previously, betting on an exponential short-term rise in a company’s share price is not investing. It can’t be.
Investing is, by its very nature, taking a long-term and disciplined outlook, expecting to grow one’s money over time. The process moves faster at times than others, but is nonetheless long-term in its approach.
Putting money into GameStop or other “meme” stocks for short-term profit is the very antithesis of investing. Sometimes speculative plays like this work in one’s favor. Many times they do not. Counting on them to work out is a recipe for disaster.
For you, the long-term investor with his or her financial security in retirement in mind as the primary goal, stuff like this is ultimately just noise. You’ll be far better off ignoring it completely, carrying on with your investment plan, and reaping the rewards many years down the road.
What’s better: Losing $1,000 in trading GameStop stock in the mania unsuccessfully, or that $1,000 becoming $5,743.49 after 30 years of a compound annual growth rate of 6% when prudently invested?
You don’t need me to answer that.