Let’s Talk About GameStop and Investing

There are few things I enjoy more than teaching people about the stock market and investing. I really could talk about investing for hours on end without taking a breath. The current climate around Wallstreetbets (r/WSB), meme stocks, and crypto is no longer about investing – it is speculation. My real concern is people thinking the recent price appreciation with meme stocks and crypto is normal, it isn’t. 

Assets have seen bubbles in the past and they’ll continue in the future. A bubble is when the price of the asset rises so far and beyond the actual value of the asset. The most famous and outlandish example is Tulipmania dating back to the 1630’s where the price of a tulip bulb was driven to over 10x the annual salary of a skilled artisan. A couple of more recent examples are the Dotcom Bubble and the Housing Bubble which both had severe consequences on the US economy. I don’t think the stock market as a whole is currently in a bubble, but I’m afraid this new attitude toward speculation in stocks and cryptos can lead to potential bubbles.

The GameStop Trade

The thing about the Gamestop trade is that it was a legitimate trade (at least from the start), which makes the situation even more confusing. The now famed Reddit user, u/DeepFuckingValue, who is also known as Roaring Kitty on Youtube and Keith Gill in “real life”, put in his time and effort and found an excellent value play. This can be seen all over his YouTube channel, but this specific YouTube video details his thesis of why he believed GameStop was a value investment. 

He uses this video to explain why the general sentiment around GameStop wasn’t backed up with the numbers they were reporting on a quarterly and yearly basis. As a person who plays video games, I haven’t been to a GameStop in years and I don’t plan on going back anytime soon. All of my purchases have been digital downloads and all of them in the future will continue to be digital downloads. So just like everyone else, I would have stayed clear of GameStop because my sentiment towards them was very poor in my own personal life.

DFV was able to look at the financials, and see that GameStop’s financial situation wasn’t as bad as people were making it out to be. People, like myself, had a negative connotation about GameStop without looking at the data. This trade is a perfect example of a value play where a company is trading at a significant discount to their actual value, which is the opposite of a bubble. He calls out in his video that he thinks that the stock price could rise to a more normal valuation within the next 18 months with the addition of new gaming consoles to the market as a catalyst for more sales. The analysis he did in his video is one that Warren Buffet would be very proud of, except Buffet would never touch GameStop because my guess is that he doesn’t know anything about the video game industry. 

DFV started to share his position of call options back in September 2019 in this Reddit post. In the post he shows his initial investment of $53k and that he was up $46k almost doubling his money. After that post, he went into the dark until he came back over a year later in November 2020 showing an updated screenshot of his position. Now, he purchased an additional 10,000 shares and held his options, making the gain on his position over $1M. This trade alone is a trade of a lifetime among a group of investors where many would have exited (myself included), but he kept holding his position. As we all know, he continued to hold and add to his GameStop position since November 2020, and as of 1/29/21, his portfolio was now worth over $46M in his latest post.

The Runup

What took this trade over the edge was the short interest on GameStop. There were more shares of GameStop that were shorted than actually existed, which is where this story takes off. Since some hedge funds, like Melvin Capital, over extended themselves on this trade creating a chance of a short squeeze. There are plenty of videos and articles which have been posted over the last week which explain what this really means if you are still curious about learning. 

Once this information started to circulate on r/WSB, GameStop evolved from a traditional value investment into trying to capitalize on a short squeeze. More and more people started to pile onto this trade and it took over the subreddit as the top trade for everyone. The stock rose over 100% during the first two weeks of January from a little under $20 a share to over $40 a share. Give it another week and it jumped another $20 a share. People were posting their incredible gains over such a short period of time. All the while, DFV continued to post his insane gains, which egged the crowd further onto buying more. DFV has now become a cult hero to the group with commenters writing “If he’s holding, I’m holding.” 

Eventually, the chatter on r/WSB started to spill over to social media. From their, the national media picked up the story and now is probably the largest financial story since the housing crisis over a decade ago. As more and more started to hear about GameStop, more and more people started to pour their money into the stock. The story also evolved into a little guy vs hedge funds story where the little guy was taking billions away from the hedge funds that shorted the stock. Other heavily shorted companies like AMC also saw a huge spike in the amount of people starting to purchase shares of their stock driving their price up.

My Concerns

I think it’s great that people are willing to invest their money into companies. Investing in the stock market is a fantastic way to build long term wealth to support yourself and your family for the future, which is a message I’m trying to spread. The current influx of people putting their money into stock for the sake of speculation or “sticking it to the man” is where I believe people can be misguided. I am in support of the individual investor, but I’m concerned people might overextend themselves. Melvin Capital and other people that shorted GameStop messed up, and they should be punished for it. In fact, they were punished by losing 53% of their money in January, or about $6 billion.

At the end of the day, it is other people’s money and I believe they have their own autonomy to choose to do whatever they want with it. I’m nervous that people could get caught up in pump and dump schemes in the near future. Someone will be caught buying shares of GameStop, AMC, or some Dogecoin at an inflated price because of FOMO. There is a point where the retail investor will get caught holding a coin or a stock at a significantly higher price than it’s valued just because they wanted to get into the action. For example, Dogecoin saw a run up to 7 cents a coin from under 1 cent in the matter of a day. Now, as I am writing this, the price of one coin is about 3 cents, or less than 50% of the peak. Like I said, people are free to do what they want with their money, but this new movement of trying to pile into an asset will not last. 

I think the internet is a fantastic place to share ideas. All of my investments have been influenced in some way by reading about the stock in an article, on Twitter, or even on Reddit. A more efficient market can be created by people sharing ideas of assets that are mispriced, but I have to fundamentally disagree with the investment strategy that asset prices will go up if you can gather a bunch of buyers. It will turn into a pump and dump scheme and that is what I want to try to avoid. 

I am a believer in being a long term investor who puts their money into companies that will continue to grow for 20+ years into the future or the general market. Day traders have always existed and they will continue to exist, but from my reading and researching most people get burned trying to do it. Some people are able to be successful at it, but the people who are most successful at day trading are the people that are selling classes on how to day trade. Selling classes is how they are making money, not actually trading and it can be very lucrative for those who gain large social media followings.

Another claim I would like to make that I haven’t heard discussed is we are still in an unprecedented time for equities. Interest rates have remained at historic lows for years on end driving up the prices of companies at a quicker rate than usual. Dating back to 1928, the S&P 500 returned +40% 3 times. 

Looking at the return of the Nasdaq in 2020, which is made up of a majority of tech stocks, it returned 43.64%. In the 45 year history of the Nasdaq, it has returned over 40% 5 times, including this past year. We have seen larger gains in the Nasdaq compared to the broader market, but such large growth doesn’t happen every year. Most of the new investors which entered the market this past year have been able to pick any tech stock and they’ve done very well for themself. I’ve benefited greatly from this too. I just want to make sure the message gets across that stocks don’t “always go up” like it is repeated across r/WSB. I know it’s become a meme on the page, but I would hate for people to lose their decent gains from this past year because they overextend themselves expecting the fantastic returns to continue.

What Happens Next?

For all I know, GameStop could go to over $1,000 a share like they are calling for on r/WSB. There is still a belief that the short squeeze hasn’t happened. The people on r/WSB are claiming that Melvin hasn’t covered their shares like they’ve said they have. I’m inclined to believe that Melvin has closed it’s position, but there could still be great short interest in the stock. No one knows what will happen next specifically to GameStop, but GameStop is a unique example of a short squeeze compared to AMC or Blackberry. My guess is that some of the enthusiasm around these other stocks besides GameStop will lessen. 

It will be great to know when everyone changes their position on GameStop from “buy, buy, buy” to “sell, sell, sell”. I have no idea when that will happen. The community is still in a holding position. Keep in mind, people don’t make money until they hit the sell button. It should also be said that before GameStop, there were mixed results within r/WSB. No trades were like GameStop for them. There were some winners, but there were also losers. I would guess their success rate of trades was probably about at the same rate someone would win at sports betting. There are some big winners, but then there are also some big losers. 

I expect the win/loss ratio to return to a normal variance after they exit the GameStop deal. Not everything they touch will turn to gold. If they expect that they think the sheer volume of the group will be the thing that brings them wealth, laws will be put in place preventing it. I’m lucky enough that I’m not the one who needs to create and execute those laws, but they will be made. The market will not be turned into a pump and dump scheme. The people of r/WSB have shown they can carry weight in the market, but that weight alone will not be the thing which drives up the prices of stocks.

I do think this situation will be turned into a net positive making investing a more equitable place. The tables are tilted towards the professionals, there is no denying that. Individuals can still do very well for themselves by taking a long term investing approach. I could see potential rules made around the amount of short interest that is allowed. For example, some European countries banned the practice of short selling. Maybe short selling won’t be banned outright, but there will be some regulation around the practice. 

One of the best things I heard from this past week was from the All In Podcast with Chamath Palihapitiya, Jason Calacanis, David Sacks, and David Freidberg. They discussed a bill which was introduced to Congress a couple of years ago. Sen. Brian Schatz introduced the “Wall Street Tax Act of 2019” which proposed to have a .01% charge on any transaction with a security. It was estimated this tax could generate $777B over the next 10 years. The people that would be affected the most by these are the high frequency trading firms. I’m in full support of this law. High frequency traders do provide some liquidity to the market, but this tax would curb their behavior. 

Chamath took it a step further saying he would propose a decreasing capital gains tax where after 5 years a person would not pay any taxes on their capital gains. This should promote long term investor behavior, which is what I really want. The capital markets provide a chance for businesses to go out and to raise money to help push the world forward. I think we should try to promote this type of investing rather than day trading. I don’t know if a capital gains tax to zero would necessarily be the right answer, but the longer you hold an investment the less you should be taxed on it. 

I think there will also be a larger conversation of how speech is policed on the internet. With the insurrection of the Capitol to Trump being banned on social media to the most recent week of trading, we are getting closer and closer to having more and more restrictions on the internet. Now that is a topic that is for another blog post. 

Please feel free to reach out if you want to talk about investing at all. I would love to know everyone’s thoughts and opinions on this situation and I’ll be watching on the sidelines to see how it ends. 

Feel free to drop me a follow on Twitter @TheRealPandL