The Psychology of the GameStop surge
How retail investors pushed a struggling business to a $28bn market capitalization
B y now, there’s a good chance you’ve heard what’s been happening with GameStop’s share price. On 27th January, GameStop’s share price reached an all-time intra-day high of $347.51. Financial markets have been thrown into turmoil by investors using social media chat groups such as Reddit and low-cost investment platforms to drive up its shares. The phenomenon has spread around the world also affecting other companies. In what is called a “short squeeze”, the share buyers are putting intense pressure on hedge funds and other institutional investors, who bet that these equities would fall.
The Story
GameStop sells video games at shopping malls. It has over 5,000 stores. For various reasons people do not buy a video games at the mall these days. Two of these reasons are: People do not like going to the mall during a pandemic, and people today increasingly buy video games by simply downloading them directly from online stores. Being a mall retailer of video games is not obviously a great business to be in, and this has been reflected in GameStop’s earnings and share price. In 2011, GameStop reported net income of $408 million on revenue of $9.5 billion. In the last 12 months, it had registered a net loss of $275 million on revenue of $5.2 billion. GameStop’s share traded as high as $62.11 per share in 2007; it got as low as $3.50 in March 2020. It closed 2020 at $18.84, for an equity market capitalization of about $1.3 billion.
But some people think GameStop is primed for a turnaround. For instance, Ryan Cohen, the former chief executive officer of Chewy Inc., an online pet-food retailer. Cohen’s investment vehicle owns about 12.9% of GameStop, which he started buying in August, when the share was in the mid-single digits. In November he sent a stern letter to GameStop’s board of directors, reminding them of what a bad job they’ve done, asserting “that
GameStop has the flexibility to evolve into a technology-driven sector leader,” and urging the board to try to do that. On 11th January, GameStop announced that Cohen and two of his friends from Chewy wouldbe joining GameStop’s board. “Their substantial e-commerce and technology expertise will help us accelerate our transformation plans and fully capture the significant growth opportunities ahead for GameStop,” said GameStop.
So GameStop, is a bad or a good company? It is a moneylosing mall retailer in a dying business during a pandemic, and traded like it, but now it will be a dynamic e-commerce leader in the rapidly growing gaming segment, and should trade like it. Share prices, of course, reflect the future, not the past. The rapid price rise in January seems to have been fueled by retail investors, who learned about GameStop online, principally on Reddit’s forum, and who have been convinced of its enormous potential. The question is how did the GameStop share price increase significantly?
It can be broken into two parts. First, a lot of professional investors are short GameStop shares. At the time, professional investors short more than GameStop’s entire float. Bloomberg reported that short interest was 71.2 million shares, while GameStop had only 69.7 million shares outstanding. They are short for the reasons I highlight above: namely, a dying mall retailer with huge valuation, etc. Second, a lot of people (on Reddit) who like GameStop didn’t buy its shares – they bought call options. An investor willing to gamble on a share, would buy call options to get leveraged exposure to the share. According to Joost van Dreunen, who teaches the business of video games at the NYU Stern School of Business, noted that the Reddit investors were essentially “playing the metagame” – a term used in role-play video games when players strategize outside of the rules of the game. In the end it has nothing to do with the fundamentals of the company, they’re just playing the financial metagame. The catalyst – helped by the availability of cash and, in some cases, stimulus checks – came in the form of the discovery of a strategy in which the usual power brokers, led by the socalled smart money (term used to refer to hedge funds), were significantly vulnerable. This strategy involved an ad hoc movement to buy the shares of the most heavily shorted companies in the hope of triggering a short squeeze and forcing the bears to scramble and cover their positions. It is a strategy that worked especially well in the case of GameStop.
Will this end badly?
At the time of writing, GameStop has lost more than 80% of its value from its high. In one day, GameStop shares dropped 60% as losses piled up on the shares. The declines were so sharp that they triggered multiple trading halts in GameStop. Those retail investors who entered the game early and closed their position would have made a handsome return on their investment. But there are investors (especially inexperienced) who came in late in the game, buying shares at the highs, or on margin, who are today may be suffering significant losses on this decision. And potentially could lose everything. It will be interesting to see what actions are taken by regulators and politicians following this phenomenon.
Dr Paul Magro is Founder
& Managing Director at Riskcap International Ltd