Stay Far Away From the GameStop Stock Madness

As I begin to write this, GameStop (NYSE:GME) stock trades around $188. By the time I finish this article, it will have moved significantly. By the time you read this, who knows where it will be priced?

A Gamestop video game store in the Herald Square shopping district in New York
Source: rblfmr / Shutterstock.com

After all, in less than three months of 2021, GME stock has gone from $17 to $480 to $40 to now back near $200. No stock in my memory has had such a combination of volume and volatility. I’d wager good money no stock ever has done so.

That volatility is telling us something. It’s telling us something very important, in fact.

GME stock is not an investment in a turnaround — not at this price, anyway. It’s not a short squeeze. Rather, it’s just a mess. It’s traders who believe they will get rich or who want to strike a blow against Wall Street, or who are just along for the ride. For many, it’s some combination of all three.

This has lasted longer than many observers believed. The core problem for GME stock, however, is that it can’t last forever.

Understanding the Story

When GameStop became literally national news in late January, the story was obviously appealing. A band of plucky traders on a relatively obscure social media platform had coordinated to execute a brilliant trade. They “squeezed” the hedge funds who were short GME, making tens of millions of dollars (at least) in the process and sending some of those funds scurrying to raise capital to cover their losses.

It was a great story. It was a fun story. That doesn’t mean it was a totally accurate story. A “gamma squeeze,” driven by market makers hedging the buying of call options, almost certainly was a big part of GME’s stunning January rally.

Still, Reddit’s r/WallStreetBets won. Give credit where credit is due.

Here’s the problem. It’s not January anymore. It’s late March. The story is not the same.

The “short squeeze” thesis is basically over. GME’s short interest has plummeted. The cost to borrow GME stock has plunged. And any hedge fund, in particular, who is shorting this stock is not doing so blindly.

They saw what happened in January. And they have protected themselves against any move. They either have the capital to wait out the other side and/or they bought their own way out-of-the-money call options for protection.

There aren’t hedge funds short GME stock who are set to blow up. In fact, there are no doubt funds on the long side of GME at this point, playing the momentum game.

This isn’t small versus big. It’s not good versus evil. It’s just traders on both sides of the trade playing something close to “chicken.” All else equal, I’d prefer individual investors win that game. I’m not sure they will.

The GameStop Turnaround

GME bulls argue that the media coverage of the “short squeeze” thesis overlooks the fact that the 2020 trade was based on fundamentals.

That’s a fair point. The massing of bulls via Reddit wasn’t just “let’s squeeze the hedge funds.” There was a strong case made that GameStop could pivot toward being a big-time e-commerce player in gaming. Even the legacy business would see a tailwind as new consoles hit the market.

That case certainly had some validity. It’s worth remembering that even before January, GME stock went on a monster run. It rallied 334% just in the second half of 2020.

It rallied to $19. It’s now at $188. GameStop has a market capitalization of $13 billion.

However, strong as the 2020 fundamental case was, that valuation can’t be supported in 2021. GameStop itself didn’t do any favors in the recent fourth-quarter release.

The issue is not so much the numbers. They weren’t great, but given the upheaval caused by the novel coronavirus pandemic, that’s not much of a surprise.

Rather, GameStop itself didn’t offer much in terms of the supposed pivot to e-commerce. There were some platitudes about a committee of board members, and GameStop added new executives as well. The conference call, however, was lacking in detail on the turnaround, and GameStop management didn’t even take questions.

Stay Away from GME Stock

For long-term investors, it’s worth taking a step back from the insane volatility and coverage of GME stock.

Don’t worry about short squeezes. Again, that’s likely not what is going on here — this seems more like simply coordinated buying. Even if it was a squeeze, squeezes by definition are short-lived. Shorts get crushed, they cover and eventually the stock returns to something approximating fair value. Squeezes are a trading catalyst, not an investment thesis.

Don’t get sucked into the “good versus evil” narrative. Hedge funds aren’t evil. Short sellers aren’t evil. And, at this point, those funds are no doubt on both sides of the trade.

Ask the important question from a long-term perspective: Is GameStop worth $13 billion?

It’s nearly impossible to say “yes.” Yes, the e-commerce business is growing — but roughly $1.5 billion in FY2020 e-commerce sales don’t support that valuation.

Yes, the stores still have some value. But there, too, is not enough to support this valuation.

That’s what matters. The rest is just a noisy game. And it’s not a game that individual investors are likely to win.

On the date of publication, neither Matt McCall nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in the article.

Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. Click here to see what Matt has up his sleeve now.

 

 

 


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