Spurred on by a Reddit message board, small investors snapped up shares of the retailer, spurring an investment frenzy.
But what was the logic behind it?
GameStop has been floundering, with only one profitable quarter in the last six. Gamers have been skipping brick-and-mortar stores and purchasing entertainment online.
Hedge funds Citron Research and Melvin Capital have been betting against the GameStop stock—a common practice known as short selling (or going short), when an investor borrows a stock, sells the stock, and then buys it back to return it to the lender.
Annello, who is vice president of investment management at Founders Capital Management in Hartford, and an adviser to the finance department’s Student Managed Fund, shared his impression of the unexpected investment surge.
What do you think was the motivation behind the GameStop stock maneuver?
I can’t get inside the heads of the people on Reddit. GameStop is in a tough spot and its business is deteriorating as streaming becomes more popular.
Also, the company makes most of its money by buying and selling used games. GameStop has had a tough year and announced that it would be closing 1,000 stores.
The company was heavily “shorted,” meaning that people were betting that the company would fail. That has been a very successful strategy for short sellers of GameStop.
Reddit spotted the opportunity for a “short squeeze,” bidding the stock and its publicly listed options up, forcing the short sellers to have to buy back stock at higher price and losing money.
GameStop was chosen for a reason –because it was so heavily shorted.
There are other companies in the same boat, including Bed, Bath & Beyond, AMC theaters, BlackBerry, headphone maker Koss Corp, and retailer Express, to name a few.
Has this ever happened before?
Well, the answer is yes and no. What we saw with GameStop has never happened this way and for this reason.
It is a novel experience in the short-squeeze scenario. But short-squeezes go back a long way. Wall Street takes great pains to avoid short squeezes from happening. Obviously, a few firms did not manage their risk well this time.
Does this independent investor buying frenzy have long-term stock market implications or is it just a blip on the radar?
Your guess is as good as mine! The cat is out of the bag. There are reasons it could happen again, some of them very technical – it has to do with the options market.
I think these Redditors have uncovered something of a market inefficiency.
A lot of people who owned GameStop stock and options made a lot of money quickly – and both they and many others will have a desire to replicate that success.
What has the reaction been to restrictions on the trade of GameStop stock?
The online stock trading app Robinhood, and some other online brokerages, put restrictions on their (primarily small, retail-level) investors buying GameStop stock, which many thought was unfair because other brokerage firms, many of whom cater to large institutions, did not have those restrictions.
Robinhood was hit with a class-action lawsuit, as some thought this created an unfair playing field.
How will this stock-price surge impact GameStop going forward?
That, too, remains to be seen. This won’t impact the core business; it is more of a sideshow. The interesting thing about GameStop is that it’s not a business that relies on having good market perception, like, for instance, a bank, where people could become upset and suddenly pull all of their money out.
One possibility is that the company could use the money to sell fresh stock, which would give the business some room to breathe.
Or, insiders, now sitting on valuable stock, could sell their stock and make a lot of money themselves. That would be a scandal. It will be an interesting story to follow.
What advice do you offer your students—or any investor?
My partners and I manage money every day and our approach to the stock market is to buy into businesses that we understand well and that appear to have a prosperous future.
We are also looking for stock that we can buy at a fair and reasonable price.
With the students in the Student Managed Fund, they have the opportunity to put into practice what they’ve learned in the classroom. They research their options and debate their choices. They do an excellent job every year.
This debacle was certainly on their minds in class yesterday, because my guess is that some of the people who were involved in these purchases and made a significant amount of money were very young. I’m sure at least some of the students were thinking, “This could be me.”
In the end, this is a speculative play in a bull market. I wouldn’t call it investing at all: Those who are bidding up these stocks are hoping to cash out before the party ends and the mice turn back into pumpkins.
They don’t really believe in the underlying business. That is not our style, and I don’t think most who try it will win over time.
There’s a lot more to be written. I’m sure this isn’t over. There are new targets likely being chosen at this moment, and there still will be profits for some and losses for many.
Written by Claire Hall.
