The common stock of GameStop (GME) has swung wildly over the past month – starting the year at about $20 a share and then quickly skyrocketing to over $400 a share by the end of January. Of late, the stock has plunged to below $70 a share. What does this mean for the average person who wants to play the market and for sophisticated institutional investors? Georgia Tech Scheller College of Business faculty Jonathan Clarke and Robbie Moon weigh in.
Moving the Market with Social Media
When a group of small-time investors from the Reddit group “Wall Street Bets” egged on their readers to buy shares of GameStop, which at the time were going for about $20 a share, they created a movement that increased the stock price to $469 a share on January 28 before plummeting to under $70 a share on February 5.
“I think this was the most surprising aspect of this case. A group of individual investors were able to coordinate on Reddit and push the price of GME significantly higher. They saw an opportunity given the very high short interest in GME. In effect, the group of Redditors was able to function as a hedge fund,” Jonathan Clarke, associate professor of finance and senior associate dean of programs, explained.
“I think it made many realize that social media enables individual investors to collectively have a persuasive voice. It’s hard for a single opinion to make a difference when held by a retail investor with a relatively small interest. However, when that idea can be easily disseminated to like-minded users, the influence becomes greater,” said Robbie Moon, Hubert L. Harris Early Career Professor and assistant professor of accounting.
Some of Moon’s research focuses on the role social media plays in capital markets, and he notes that this research suggests that Wall Street investors’ information advantage seems to decline as more information is disseminated on social media.
A Short Squeeze
Given its declining revenue and profitability over the last five years, GameStop was heavily shorted by institutional investors. With short-selling, investors are betting that the price will decline in the future. The unexpectedly intense buying pressure coming from small investors forced short sellers to cover the positions at higher prices than anticipated and further contributed to the upward movement in GME’s stock.
“Wall Street Bets was able to initiate a movement that exerted tremendous price pressure on the stock, but that really happened because the short sellers left themselves so exposed,” said Moon. Some prominent hedge funds lost big in the short squeeze. Melvin Capital, for example, experienced losses of over 50% for the month of January. I think hedge funds will be more careful with their short strategies, hedging much of the risk they faced in this case,” said Moon.
We’ve Been Here Before
For Clarke, this entire scenario is nothing new. This is a classic example of ‘pump and dump scheme’ he explained, adding that there was also a short-squeeze in 2008 when Volkswagen briefly became the world’s largest company by market cap. “This isn’t historic or unprecedented. We know how this is going to end,” said Clarke. “It’s going to end with GameStop falling back down to its fundamental value.” Moon agrees, though comments “To my knowledge, this is the first time a squeeze has been so openly coordinated.”
Clarke predicts that the ones who will be most affected are the very ones who caused the disruption. The small-time investors who thought they could pay off their student loans or purchase a house or car with their capital gains from GME will, in short order, lose a lot.
Clarke claims that the road leading to financial success is measured. “The best way to build wealth is to live beneath your means, buy into the market whether it’s up or down, hold for a long period of time, and avoid paying fees. It’s a timeless strategy. It’s boring but it works,” he advised.
