Modern communication infrastructure can facilitate swift simultaneous action by a large number of people. If used to coordinate a surprise attack, an organized mob can overcome a store or even the capitol building. Is Wall Street the next target?
GameStop is a brick-and-mortar retail chain that was losing money even before the pandemic. Yet the price of its stock increased 1,900% in January on the basis of no particular improvement in fundamentals. The rocketing price seems to be a classic short squeeze, with a new twist: the grip of the squeeze came not from a deep-pocketed individual but by the internet-coordinated action of a large number of small investors.
GME price, Feb 5, 2016 to Jan 29, 2021. Source: Google Finance.
To understand what a short squeeze is all about, let’s start with a simple example in which the issues will hopefully be very clear. Suppose there is a company that you are convinced is going to be able to make one more dividend payment of $1 to each shareholder before it goes out of business next year. Even though the company is headed for bankruptcy, the stock has some intrinsic value, namely the $1 that each owner of a share will receive as dividend. If the stock sells for $2, it would be overpriced, and you might try to profit by selling the stock short.
To do that, you could try to borrow a share from a dealer so that you can sell a share for $2. You would have to put up funds (known as margin or collateral) to prove that you are able to cover the $1 dividend payment and capable of buying the stock outright if you were forced to. If after your short sale other market participants start buying a lot of shares and drive the price up, you’ll have to put up more funds to prove to the lender that you still are able to buy back at the higher price to fulfill your original sell. If you can’t do that, the dealer who originally lent to you will use your collateral to buy the shares outright and close out your position. The buy orders from the closed-out shorts can then add to the buy orders from the rest of the market to drive the price skyward.
In the case of GameStop, the buy orders that drove the squeeze came from large numbers of people getting information from financial news discussion sites.
So do the squeezers profit at the expense of the shorts? Let’s follow our hypothetical example one step further. Suppose that the shorts had it exactly right — the hypothetical company is about to go out of business. Next year the squeezers who bought the stock get their $1 dividend, but that’s all they’ll get. And they paid much more than a dollar to buy each share, for their buy orders were what originally drove the price up. They can only make a profit if before the company goes bankrupt they sell the stock to somebody else who’s willing to pay more than a dollar for it.
And to whom do they sell the stock? As Shakespeare might say, aye, there’s the rub. If they sell to the original shorts, there’s no squeeze — the whole operation only works if the shorts can’t find anybody to sell to them. So where will the squeezers find the person who’s willing to pay more than $1 for the security? Another chat room, perhaps?
In our hypothetical example, every buy order in the original squeeze paid more than $1 to acquire something whose value, if held to maturity, was only $1. The mob as a whole therefore had to lose money. The shorts whose positions were closed out certainly also lost money. So who gained?
The answer is, the people who bought into the squeeze early and then sold their positions to the gullible parties farther back in the mob. The mechanics are basically those of a chain letter. The original buyers may make some handsome profits, but only if they sell in time. The followers, on whose participation the whole process depends, must lose big. A profitable squeeze requires some gullible victims who end up absorbing the losses that are a necessary component of the strategy.
The feature that makes this hypothetical example crystal clear was the assumption that the company would be out of business in a year. That allowed us to see unambiguously that, as events turned out, the stock had an indisputable fundamental value, namely one dollar per share. But the math works out exactly the same for a company that’s going to pay dividends for two years and then go out of business. In that case, the fundamental value is the discounted value of those two dividends, no more and no less. It’s also the same math for a company that’s going to pay dividends for five years and then be bought out by some other company. The fundamental value is the discounted value of the five dividends plus the discounted liquidation value. Real-world examples may have lots of details and lots of contingencies. But the underlying principle is still the same. Any asset has an intrinsic fundamental value, which is the discounted value of cash flows that accrue to the owner of the asset. If you pay more than this, squeeze or no, you paid too much, and are counting on selling it to somebody else who is even more gullible than you.
The moral is, you can get hurt trying to stand in the way of a crowd, and you can get hurt trying to join a crowd. Personally I prefer to take long positions all by myself based on fundamental values.
And I for sure am not buying GameStop.
I’ve not followed this story all that closely, but my understanding is that a lot of the players were more interested in using house money (e.g., stimulus checks and beer money) in order to stick it to the man. It wasn’t really seen as an investment with any real expected return, just the cost of buying a cheap thrill. Since you can’t find entertainment in the usual ways like going to concerts, why not get your jollies by kicking the bad guys on Wall St? The money you might lose is just the cost of entertainment much like the way people view money lost at any casino.
it started out as a somewhat legitimate trade a while ago. some redditers found a short position, which was available public information, that had an expiration of last friday. that was the original exploitation, and what caused the stock to run from $4 to $40. this was the nucleus. then the chaos kicked in, like you said. to stick it to the man. many of thsoe folks are willing to lose $500 bucks to kick the bad guys, as you said. what you saw last week was ridiculous and will cause many of those rioters to lose money. they don’t seem to care. as of now, anybody who has a publicly known short position with a short term expiration is at risk.
Crocodile tears for the hedge funds that got burned…
Did you even read what Dr. Hamilton wrote? Look – that the hedge fund types got burned is cool but a lot of small investors are going to lose a lot too. But I guess an angry troll could care less about that.
pgl taking the side of the hedge funds…how unsurprising!!! As for small investors, they had to know that they were gambling, pure and simple. If they didn’t know that, then this was a real lesson on the dangers of swimming with sharks.
“that the hedge fund types got burned is cool” is taking the side of the hedge funds??? As usual, you are just an angry idiot.
Yea any smart person would know this is gambling in a rigged game. Then again our angry carnival barker first thought these people were not getting hurt. Which makes you the biggest idiot of them all. But hey – that was obvious to EV readers for years.
You mean that in the flood of vitriol and snarks emanating from pgl, he actually says something sincere? Wow!
What’s even richer is that he gets livid when someone misrepresents what he said…something that he does as routinely as opening his mouth.
Another excellent discussion of this GameStop market manipulation that I’m sure you will never understand:
https://arstechnica.com/tech-policy/2021/01/the-gamestop-bubble-is-going-to-hurt-a-lot-of-ordinary-investors/
The title makes clear that the little guy is getting hurt just as a few hedge fund types by some other Wall Street type scam. And of course you thought this was a win for the little guy because you do not understand even the basics. Do we need to draw this in crayon for you?
You should pay attention to Senator Warren. Unlike you she gets this stuff:
https://www.cnn.com/2021/01/31/investing/elizabeth-warren-gamestop-sec/index.html
A lot of people are going to get hurt by this market manipulation. The SEC needs to do its job and figure out who is manipulating the market on both sides.
Flash mob finance as opposed to hedge fund finance.
The flash mob was trying to drive up the price of shares by buying lots of shares. The hedge funds were trying to drive down the price of shares by shorting and selling lots of shares — as much as 140% of the float.
Both were trying to manipulate the price of shares in a direction favorable to themselves by flooding the market. Turns out the squeezers won this round, costing the hedge funds billions.
And if you want to find good guys or bad guys, the efforts of the hedge funds were to drive the company into liquidation as quickly as possible and put their 14,000 employees out of a job. That’s the way shorting hedge funds win.
joseph the efforts of the hedge funds were to drive the company into liquidation as quickly as possible and put their 14,000 employees out of a job.
I’m not following you. It’s not obvious how selling short can put a company into liquidation anymore than buying long can keep a company out of liquidation. GameStop was a failing business for the simple reason that gamers no longer buy physical games at brick-and-mortar stores. I don’t think there’s anything inherently bad about hedge funds. It can serve a socially useful purpose. In principle selling short is no different than someone waiting to buy a new mattress until the next President’s Day sale.
You can find examples where it has negative or positive impacts. It depends on the context.
https://foolingsomepeople.com
What is bothersome is some of the rules which hurt small investors from playing with the big boys. For example, I know at one time, and I assume it’s still true, you couldn’t short stocks in a retirement account or a pension account. How does that help investors when markets are being slaughtered?? My personal stance is it doesn’t. It rewards bankers, brokerages, hedge funds etc for playing both sides of the trade. While telling small investors you either have to play the long side of the trade or “go home”.
Short sales can increase market efficiency, in making more of the minutia of balance sheets “available to” (or more apparent) the broader public. But it can also tie board rooms hands when looking to equity markets for new sources of revenue (capital needed for sliding over into other more contemporary business models). By shortening the time margin or time window, short sellers can be destructive to companies which may have been able to survive the storm.
personal retirement accounts have some limits on the types of trading you can do. these are also accounts with special tax status. nothing stops you from cashing out a portion of the account, moving it into a regular brokerage/margin account and trading at will. i think it is actually quite reasonable to protect individual retirement accounts from more sophisticated trading. as an aside, this does not mean an individual cannot play short or hedges in retirement accounts. many pension funds are invested in hedge funds, so folks can/do have exposure to these types of trades in an indirect manner. but it is wise to keep such trades out of direct reach of the vast majority of people when it comes to tax treated retirement funds. if you think social security is not enough for retirement, making their retirement stock accounts more risky is probably not a good approach. most would lose money, and only a small margin would actually profit, in my opinion.
“In principle selling short is no different than someone waiting to buy a new mattress until the next President’s Day sale.”
true in principle. but if you wait to buy on president’s day sale, you may simply run the risk of mattress being out of stock, with no rain check. however, if 140% of the float is short, there seems to be a problem with the supply constraint for shorts. the supply rules seem to be different for long and short positions.
Normal day to day short selling, in theory, is harmless. But in Gamestop’s case, the hedge funds were manipulating the price by shorting 140% of the existing stock. They absolutely wanted to drive the company into liquidation so they could cover their shorts at zero cost for a 100% profit. And they wanted to do it as quickly as possible to reduce their short borrowing interest. The quicker the company went bankrupt, the more money they would make. By driving the stock price as low as possible it reduces the opportunity of the company to borrow and reorganize.
The hedge funds didn’t give a damn about the company or their employees or even if they sold shoes or games. They simply saw an opportunity to manipulate the market and make a lot of money. That’s all they care about.
Prof. Hamilton’s explanation strips out any specific reference to the actual facts occurring with GameStop. I get that is not entirely fair to criticize an explanation for not explaining something outside the scope of its intention. But you reference shorting 140% of the existing stock. I get that you can short by buying an option to sell at a price, but such shorting is not subject to squeeze, just the loss of the option price. If I understand, legal shorting requires the “borrowing” of the stock from a true owner. So, how does a short position grow to 140% of the float? I have been looking for an explanation that would “prove” that the big short players are not engaged in naked shorting, which I understand is illegal. So, everytime someone says no illegal behavior is going on, I wonder: who proved that? Moreover, the explanations, for a convenience that I can appreciate, leave out any discussion of leverage, which can be its own separate problem. Lastly, not every writer has accepted that GameStop was doomed, and just because shorting may provide some value when it opposes some fraud that pushes a scheme on the long side, its value does not prove that shorting cannot be an abusive tactic. I think that is the point your comment makes successfully.
How 140% of the float was sold short is going to be key to any investigation, and heads are probably going to fly. For example, options traders, in their day-to-day trading, typically need to be able to sell stock short in order to hedge options positions. Their clearing firms will send out a notice to members that a stock is “hard to borrow” or “impossible to borrow”. In other words, the clearing firm will not allow you to short stock unless it knows of shareholders who are willing to lend shares for short selling. If a stock is “hard to borrow”, think carefully about how you want to trade options on it.
For the vast majority of companies, borrowing stock to sell short is no problem. In fact, if you have a Schwab or ETrade account, your holdings may have been lent out to a short seller, or if you own a mutual fund it likely lends out it shares for a tiny sliver of income. In the normal course of the market it doesn’t affect you. But sometimes, perhaps because the stock is already heavily shorted, it becomes “hard to borrow”.
What I don’t understand here is how GME managed to get a short interest ratio over 100%. If a short seller sold shares, he wouldn’t have been able to deliver the shares, and the trade, as far as I know, would have been “busted”.
One way one can have more than 100% of a stock sold short is that if it has been falling sharply in price and most of the shorts were bought previously when the stock price was higher. So the sum of the shorts can exceed the currently reduced total valuation of the stock., which is not at all out of the question when there has been a lot of shorting, which tends to drive a stock price down.
joseph I’m still not following you. I don’t see how the price of the stock could ever fall to zero as long as there is some expectation of a positive dividend. What drives the stock price to zero is the expectation of never seeing a dividend. In fact, as long as the expected dividend is constant, lowering the stock’s price only makes the stock more attractive because it lowers the P/E ratio. And the ability of a company to borrow and reorganize should be based on the profitability of the planned investment, not the share price of existing equities. Any competent lender should be able to identify and discount the information content in a clearly manipulated equity price. In GameStop’s case the problem was always with its business model fundamentals. It’s because the company was already heading for zero dividends that short selling looked attractive and not the other way around. GameStop is facing liquidation because of its business model, not because of short selling. And flash-mob buyers pumping up the stock’s price won’t keep GameStop out of liquidation.
I don’t own any Gamestop. I am neutral in my thoughts on the purchase or sale of said equity. Still, after watching hedge funds and other Wall Street fatcats do predatory trades based on “front-running” retail investors’ trades for YEARS, i’d be lying if I said I didn’t get the most hearty of chuckles out of headlines such as these:
https://www.cnbc.com/2021/01/27/hedge-fund-targeted-by-reddit-board-melvin-capital-closed-out-of-gamestop-short-position-tuesday.html
There’s also some very “odd” verdicts in bankruptcy courts where preferred stock shareholders and bond holders run off with a lot of equity. Not sure if that “rankled” any economics profs into a blog post about banks extending endless credit/loans/bonds to the “smart money”. Will we exhibit the same skewed/inquisitive glance when guys like Eddie Lampert run off with shareholders’ equity and probably well over $1 billion in real estate by robbing Sears shareholders blind??
https://www.nytimes.com/2018/10/18/business/sears-bankruptcy-edward-lampert.html
Was what Lampert did “legal” or “moral”?? And is there anything AT ALL any academic economists would like to write about the legal system that allows such behavior?? Not giving any TBTF bank endowed Economics Dept Chairs for writing those papers?? NO adjoining/attached complicated math equations there??
I guess that’s not as entertaining as condescending lectures to the “retail investor” or “dumb money”.
eddie lampert was a lesson for me. i lost money to lampert in sears. not a lot, but enough to learn some serious lessons. one is never to take advice from jim cramer or another talking head without doing the research myself. what lampert did may be legal, but it is because people like him are able to have the rules written to their advantage. eddie may not deserve jail time, but he should be living in the poor house right now. his profiting from sears is problematic, especially as he took over some management positions.
The mob doesn’t necessarily lose money as a whole because they gain from the shorters’ losses. It doesn’t take all that many shares sold at $325 to cover purchases made at $15 or less. Successful squeezes make a *lot* of money. True that distribution issues are a big deal and there will be some big losers among the shorters.
Now for some of the other companies, things may be very different. Most of the profits from the squeeze went to the holders of that 600 million convertible bond issue. With that now out, the stock is going to be really hard to squeeze, especially with the distribution issues; squeezers jumping in now are likely to use money.
I have seen comments of several buyers holding that they were in fact going after the funds and other BIG money investors. And, yes, they understood that their money was lost. As Jim points out in his flash mob analogy: “In our hypothetical example, every buy order in the original squeeze paid more than $1 to acquire something whose value, if held to maturity, was only $1. The mob as a whole therefore had to lose money. The shorts whose positions were closed out certainly also lost money. So who gained?” Another question is: How much gain or loss? Small buyers lost little, as 2slugs points out, “house money”
My explanation is that there is so much pent up anger in this country, that these times of semi-spontaneous actions are growing. Any here remember DC Jan 6th and Portland through last Summer?
Betting on a stock as the same thing as trying to murder the Speaker of the House? Let it to CoRev to call all QAnon on us!
my guess is this action would not have occurred if there were still $5 trade commissions, and certainly not when it was over $25 for a commission. free trading has changed how people are willing to trade and handle risk. people have been asking “why didn’t this happen sooner?”. we have had overall commission free trading for about a year or so, and it could not have happened previously. the friction of commissions was a big deterrent, but now people can incrementally by a share at a time, and this has changed their risk appetite. remember a $5 commission is double for buy and sell.
The guy who started the hype of GameStop in the first place cashed out 31 million a few days ago. He is certainly one of the winners. The business model of RobinHood who did a lot of the “free” stock trading (that the mob executed) is basically to sell its costumers to a company that front runs them and then RobinHood get a cut of the profit. So they made a lot of money from all that trading. The rest of the profit is with the professionals that already have or will get out before the fall, rather than thinking its not cool to get out (or that its actually cool to lose money).
You refer to front running. My understanding of front running comes from a read of Flash Boys. From that, I would think that front running is an entirely separate problem. It may occur at the same time as a short squeeze, but I do not understand that there is any relationship between the two, unless there is some other part of the picture like RobinHood promoting the squeeze because the squeeze jacks up volume to multiply the profit from front running, or something of the sort.
No you are right that the short squeeze and front running is two separate issues. The people using RobinHood are sold the idea that they get to do “free” trades so they are much more likely to get into the game than if they actually were told what it costs them. This is the reason you have such a large number of amateurs on that particular trading platform. The internet forum that gathered those forces to execute the short squeeze was pushed by a guy who pretend to be a regular guy but actually was a financial advisor before he began this gig. He is the one who harvested $31 million a few days ago (and you can also say he was front-running the amateur (or doing a pump-and-dump scheme). Personally I am happy to see hedge funds lose a combined $5 billion on a short squeeze. My concern is that some of the people taking the rest of the loss as the company go from a market cap of $24 billion to $2 billion (its value before the pump to off like a rocket). Wall street has left that stock and taken their loses; someone else will take the remaining $17 billion of loses. I saw one of these RobinHooder’s had lost a big gain, then “invested” his $20K student loan to “get it back”. Also some of the fake identities in the Reddit forum were glorifying “staying in” and posting large loses. That kind of stuff concerns me, not for the sake of Wall Street professionals, but for these marks.
“That kind of stuff concerns me, not for the sake of Wall Street professionals, but for these marks.”
agreed. there was money made leading up to last week, at the expense of the hedge funds. at that point, those squeezing should have taken their money and run. what happened last week was a bit of a sham. as the stock broke through $200 and over $400, those were not shorts getting squeezed. those were longs left holding worthless stock. looking at the volume, it was smaller at those higher prices. but those are not the pros holding the bag. this will not end well for anybody with a long position on a worthless stock. the squeeze was transitory. the stock is mostly worthless if you are holding it today. best to unload when you can, especially at a profit. soon you will be fighting shorts at $200, and that is a losing proposition.
My suspicion all along has been that smart traders saw an opportunity to use a visceral vendetta against big hedge fund traders as a way to pump up the stock price and then get out early. People who were buying at the high end very likely knew that they weren’t going to come out financially ahead on this. They were just buying the stock for the personally satisfying experience of sticking it to the Big Boys on Wall St. The money they lost was just entertainment money that they would have blown on something else if it weren’t for the pandemic. Who’s to say that they didn’t get their money’s worth even if they lose everything they put into the market? It’s the difference between buying an investment and buying an experience.
i personally prefer my investments to be profitable and my experiences to be in the waters of maui! but to each there own, i guess!
2slug,
This is the pattern of pretty much al bubbles, although usually these things work themselves out over longer periods of time than this fandango. One has the smart/well-nformed insiders who buy low at the beginning and then get out before it crashes, making money, and then the later arrivals, the sucker/losers who buy high and lose money: as it was put in the South Sea Bubble of 1720 in Britain, “the widows, ministers, and others” who don’t know what they are doing. After all, legend has it that Bernard Baruch dumped all his stocks before the October, 1929 stock market crash when a shoeshine boy gave him “hot tips’ on stocks to buy.
+1 to Ivan. Follow the money. Nothing is as it seems.
We making running a Ponzi scheme a crime but somehow people celebrate this manipulation? Come on people – the guy who started this scam should be investigated by the SEC and put in prison next to Martha Stewart.
I’m just hoping they’ll come after I stock I own!
Excellent analysis and presentation.
a big problem with selling short is who owns the stock. if i own the stock long, and for whatever reason agree to enter a short contract with somebody, this is fine. on the other hand, naked shorts still seem to exist and that is a problem. here is the issue i have. somebody other than me (brokerage house, market maker, ???) seems to be able to “borrow” my shares in order to make a short deal. retail brokers seem to have used this ability to help make a profit, now that trades are commission free. the ability seems to be bigger than simply shorts, and applies to other trades and options. now my issues with this is two fold. first, they are making money off of my asset. perhaps that is the price to pay for commission free trades, since the whole pie cannot be free. but more importantly, if i own a stock long, i do not want that same stock to be made available short. that is not in my financial best interest. its one thing to let a brokerage (or other entity) use my asset for possible profit, but if it is used to make a bet AGAINST my current position, i have an issue. this is troubling. and not clearly explained to the vast majority of retail investors. and probably a reason why robinhood ran into issues last week. 140% of the float short is a problem. short trades should not be able to trade as fluidly as long trades.
2slugbaits: “And the ability of a company to borrow and reorganize should be based on the profitability of the planned investment, not the share price of existing equities.”
I realize you are taking the Gordon Gekko side of the debate “Greed is good” because it more efficiently allocates capital.
But you can’t have it both ways. You can’t say that shorting stock prices allocates capital more efficiently and in the same breath that that allocation of capital has no effect on the welfare of a company. The contradiction is obvious and makes you sound stupid.
Stock pricing is, in theory, a signalling process and if shorts are depressing the stock price they are trying to scare away investors. Of course this affects the ability of a company to borrow and reorganize. And the more they can depress the price, the more dire the company’s fortunes look. There is no doubt that the shorts were trying to manipulate prices to torpedo the company.
As a counter example you can look at Tesla, who up until very recently was in danger of bankruptcy due to their inability to cover loans, but with their soaring stock price, they were subsequently able to borrow hundreds of millions and issue new debt.
But Tesla has a chance of being a viable business model. GameStop – not so much. Not that I’m buying Tesla stock at the current price.
in a little bit of irony, GameStop could actually issue more stock at these exorbitant prices so that the short sellers can find a stock to cover with. it appears there is not much float available to cover the shorts at this point. this would net GameStop a huge sum, and ironically permit a short trade to benefit the target company itself. have not heard if GameStop issued any stock yet, but i heard that had filed a while back with sec to permit an issuance from time to time. this would help the shorts and hurt the squeeze.
joseph You can’t say that shorting stock prices allocates capital more efficiently and in the same breath that that allocation of capital has no effect on the welfare of a company.
We’re not talking about allocating productive capital. In the case of GameStop it’s simply a matter of reallocating the ownership of existing capital. Short selling does not make the company less viable. It’s the other way around. It’s the lack of viability that drives the short sale. There’s no question that these financial games will create winners and losers among the investors, but the gains and losses are strictly between the traders, not the company.
look at Tesla, who up until very recently was in danger of bankruptcy due to their inability to cover loans, but with their soaring stock price, they were subsequently able to borrow hundreds of millions and issue new debt.
You’re confusing the phenomenon (viz.,the company’s underlying business model viability) with the epiphenomenon (viz., the equity price). It wasn’t the soaring stock price that enabled Tesla to secure a loan. Tesla would not have had a soaring stock price if investors didn’t already believe in the company’s future profitability. Investors didn’t loan Tesla money because Tesla had equity prices. Investors loaned Tesla the money because they understood the difference between a short term liquidity issue and a poor business plan.
“Greed is good” because it more efficiently allocates capital.
No, greed does not allocate capital more efficiently. The efficient allocation of capital depends upon full and transparent information. Greedy people usually aren’t known for sharing information with others.
Dean Baker weighs in:
https://cepr.net/the-gamestop-game-and-financial-transactions-taxes/?emci=17cf9605-b564-eb11-9889-00155d43c992&emdi=ef37a946-b564-eb11-9889-00155d43c992&ceid=4616197
He seems to be on the same page as Senator Warren.
pgl,
Well, Dean has supported a fin transactions tax forever. It might slow this stuff down, but it will not stop it.
To his credit – Dean admitted that.
So, Jim, I cannot resist. I find it interesting (and actually reasonable) for you to rely on various reports about dividends and analyses of Gamestop’s prospects in order to essentially assess its fundamental value. Needless to say this is not using econometrics.
This is an interesting contrast with your old position regarding the inability of using econometrics to estimate fundamentals, the “missspecified fundamental problem,” supposedly lying at the base of not being to call any price series a “bubble,” a position that I think occasional commenter here, Bob Flood, has also supported.
I do not know Menzie’s position on this (I may still be trying to stimulate a round of fisticuffs between you two), but his major prof who posts here sometimes, Jeffrey Frankel, has a long history of recognizing other data sources for trying to determine fundamentals, or at least such things as attitudes to risk in comparison with econometric estimates in forex matkets, considering such things as surveys as serious sources.
As it is, I am not disputing that it does not seem that there has been any change in the apparent fundamentals of Gamestop that would justify the large increases in its stock that we have seen.
I’ll grant that dividends may not always be a great predictor of expected future free cash flows, but this is GameStop. Now if you have reasons why its expected future cash flows are several multiples of its current dividend, you should call Glassman and Hassett and help them write an update to their 1999 book. Just saying!
Of course the valuation of a company is more than the expected future cash flows as we need to specify the cost of capital. Glassman-Hassett looked at a 4% real government bond rate and assume a zero equity risk premium. Now the real interest rate on government bonds may be zero, but not so much the equity risk premium, which this would put at the beta in excess of 1.4 times the equity risk premium which conservatively is 5%:
https://finance.yahoo.com/quote/GME
So tell me how a cost of equity = 7% or more and the dismal expected future cash flows of this company justify its current market valuation?
One can draw an analogy to how Berkshire Hathaway (Warren Buffett’s empire) is Coca Cola’s largest shareholder holding about 10% of their shares. At $48 a share, the market value of this company is near $200 billion so Warren and his empire holds $20 billion in Coca Cola. A huge sum to most of us but not to Warren’s empire.
Warren is not into gambling or market manipulation but let’s suppose he wanted to manipulate the market for Coca Cola. He could try driving the stock up by doubling his holdings to 20%. But I guess coming up with an additional $20 billion might be difficult for even Warren.
Or he might try driving down the stock by selling all of his shares. But wait, that is indeed only 10% of the shares of a very valuable and well known company.
But wait – I forget about short selling. Now if Warren doubled his negative play, he would have not just the original $20 billion in cash but another $20 billion from the short sell. And this additional 20% of the stock on the market might depress the stock price. To which Warren gets to buy back shares on his favorite soda company.
So why does he not try this stunt? Is Warren just a good guy? Or is it that if he made these moves, people would notice. This is why we need transparency and an SEC that punishes market manipulation on both sides of the transaction
I seriously doubt that the Reddit activists alone were responsible from the GameStop debacle. It’s likely that there was serious money from large investors be they hedgies or not on the other side of the shorts. There is a long history of internecine spats between fund managers (read the laughable fight between Icahn and Ackman over Herbalife). Maybe a couple of Reddit folks made some big money (I hope they put aside money for estimated taxes as they will face a rude surprise in that their earnings will be taxed at personal income levels and not the lower cap gains rate because of the short holding time.), but given the volume of trades I think some hedge funds did much better. This was the perfect opportunity for flash trading which RobbinHood cannot possibly accomplish.
Fortunately, trades such as GameStop do not pose a systematic risk to the market as did the Long Term Capital Management guys in 1998 or all the financial engineers who created derivatives so opaque that nobody could assess the absolute risk back in the 2000s. It is sad that a fair number of gamblers will lose money on GameStop but the house always wins when investing turns into gambling.
“There is a long history of internecine spats between fund managers (read the laughable fight between Icahn and Ackman over Herbalife).”
That Herbalife and its overpriced junk science is still in business is a scandal all by itself.
Not mentioned in these discussions is the income statement for GameStop. Back in 2017 and 2018, this company was generating $8.6 billion in sales per year with a gross margin near 29%. Its operating expenses were about 24% of sales. Not bad. But then in the year before COVID19, sales fell to less than $6.5 billion with operating expenses jumping to 29.5% of sales.
Now if a miracle occurs, sales and profitability might go back to their old levels which would support a modest stock price. But if there is no miracle turnaround, the fundamentals for this company are basically bankruptcy. And yet some people were paying over $300 a share? Definitely a Ponzi scheme.
It is my understanding that a Ponzi scheme has a specific meaning identifying a particular type of fraud, and no description here is anything like a Ponzi scheme. Also, there are a lot in the comments that is worry for a lot of “little” investors that is trolling. Hypothetically, I buy 1000 shares at $10 and the price goes to $100; then I sell 100 shares. Then the price goes to $300. And so I am going to lose my shirt when the price drops from $300 to $20? No. I do not sense that anyone above writing comments is writing upon actual knowledge of who traded what shares, at what prices. Of course some people will have lost money and that is tragic when it is someone who has deluded themself with a lot of misunderstanding. But if some, that is some, hedge funds lost a lot shorting, I have a hard time finding tears for them. Were they not the professionals who were supposed to know what they were doing? And no one has proven that they were investing legally or serving a public purpose.
i have no reason to defend the hedge funds. those that lost knew the risk. that is their profession. and some made money, so be it. it was nice to see the big boys get bullied for an instant, but that will not be the norm going forward. as for the small investors, i am happy that some won big. and i am sure that some lost, hopefully more potential profit than actual cash. but that again is part of the risk of trading. day traders need to understand this. but i will not defend the reddit traders to a great degree. they had a plan and implemented it. was is collusion? hard to say, when it is millions of folks making small trades. and those that got out early enough, great. those that stayed? tough call. but if anybody took the time to read that reddit board last week, you will probably come to the same conclusion i did. this morphed into something i am not very comfortable with, and i have little sympathy for those involved after about tuesday of last week. that reddit board was ridiculous, and filled with caustic and antagonizing commentary that riled up the public, just like the trump speech on jan 6. those left holding those $300 shares of GameStop were neither day trading nor investing, they were hunting. they should not be in the market.
I’m a bit tardy getting back to something dilbert dogbert suggested – that Governor Ronald Reagan passed the largest state tax in history back in the 1960’s. He did back in 1967/68 with the details noted here:
https://calbudgetcenter.org/blog/the-largest-tax-state-increase-in-history/
Note it was Bruce Bartlett who worked for President Reagan that reminded us of this fact.
If you are investing in the construction and the manufacturing sectors, you might be doing well as New Deal Democrat documents that economic activity in these two sectors is “on fire”:
http://bonddad.blogspot.com/2021/02/the-two-most-leading-sectors-of-real.html
Now Bruce Hall was all upset that people that could be building the Keystone Pipeline might have a hard time finding other jobs. And he wonders why we call him Bruce “no relationship to Robert” Hall.