David vs. Goliath: The GameStop Story

Think about the last time you walked into a GameStop. If I had to guess, it would have probably been years ago to buy a new videogame or to pick up an Xbox 360. However, in the last few years, it has become irrelevant as everyone can buy their video games and accessories online directly from the game publishers or on Amazon. This has caused their stock to plummet over the last few years, falling from an almost $60 share price in 2013 to a single digit stock by 2020. However, in the last two weeks, shares have skyrocketed over 1500%, and people from the average Reddit user to every financial analyst on Wall Street are talking about it. This begs the question: why do people care about GameStop again?


Let’s Start with Some Background about GameStop’s Stock


GameStop trades under the stock ticker (GME) and over the last few years, it has been every hedge fund’s favorite stock to short sell. Short selling or (shorting) is a speculative way of investing where a trader essentially makes a bet that a stock will go down. They are “borrowing” shares of stock to purchase at a lower price. If the stock price drops, then a short seller becomes profitable, however, if it rises, the short seller can create huge losses very quickly. So for years, GameStop had been the target of short sellers to the point where it had been wildly over-shorted. For a long time, it had been a profitable strategy but with the combination of high demand for new game systems and a Chewy.com founder joining GameStop’s Board of Directors, the stock rose a bit in price.


Then Reddit enters the arena


On a popular stock trading forum subreddit called r/WallStreetBets, some traders noticed an opportunity. They realized that if enough people bought GameStop’s stock, they could cause a short squeeze. A short squeeze is a rapid increase in stock price caused by short-sellers trying to close their positions by buying back the same stock. This causes a lack of supply and high demand sending the stock price soaring. After a few r/WallStreetBets posts about this opportunity became popular, people started rapidly sending in buy orders for GameStop stock. They successfully caused the short squeeze, and all the large Wall Street companies that were originally shorting the stock had to then buy the shares in order to stop their losses. This compounded the effect and GME rose rapidly. Eventually, the Reddit traders took this opportunity personally and decided that they wanted to make the massive Wall Street firms hurt. They continued buying the stock and formed a rallying cry to get all the smaller average Joe traders together to “win”. The stock quickly doubled, tripled, and is now over 1500% higher than where it was not long ago. At the market close on 1/27/21, GameStop’s stock price sits at $347.51. It is estimated that Wall Street has lost over 5 billion dollars through their short sales on GME and hedge fund managers everywhere are hiding under their desks. Now, does this mean that the little guy beat Wall Street? Not quite. While 5 billion dollars is an incredible amount of money and will definitely hurt some firms, Wall Street companies are making plenty more money than what they lost.


Implications


This trading phenomenon caused by Reddit has made some interesting plays on the broader stock market. The trend of looking for short squeezes has spread to other stocks: AMC Theatres, Blackberry, Nokia, and other seemingly irrelevant companies have all been trading wildly on the market. The large Wall Street firms that have been shorting these stocks may have to start looking out on forums to see if they will fall into the same mistakes by overly-shorting some companies. There is also a chance that the SEC (Securities & Exchange Commission) may impose some regulation to limit this from happening again, however, it may be too early to tell what moves they take (or even can take) in this scenario.


Is this the first time that this has happened?


No. While bands of Reddit traders may have not had such an impact as this in the past, they have taken similar actions before. Just a year ago, Hertz had filed for bankruptcy and Reddit users decided that they wanted to buy their stock and a similar event occurred. A year before that, r/WallStreetBets became very fond of Tilray, a medical marijuana company, and bought their shares like crazy. A similar thing happened to Beyond Meat. So while this may be all you hear about right now, this was not the first instance of this happening and likely won’t be the last.


So I should go buy GameStop stock right?


No. Don’t let that be a takeaway from this post. While I applaud the people who first saw this opportunity on Reddit and I hope that they made nice profits, anyone purchasing the stock now is not investing, but gambling. Nothing that happened to GameStop happened because of company fundamentals, but purely public opinion. “Investing” in GME, AMC, BB, or any similar companies for the sake of turning an instant profit is no better than throwing all your chips on Red Odds at the casino. If you know that you are simply gambling and not investing then do as you please, but don’t think that you are investing. Instead, go buy some shares of an index fund and let the average market return make you rich.


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