This was supposed to be the beginning of earnings week on Wall Street, when companies answer questions about their most recent sales and profit numbers. Instead, there is only one question investors want an answer to right now: Why did GameStop stock rise the way it has this month?
If you look at the chart of GameStop stock so far this year, you’ll see something truly astounding.
GameStop stock rose from $17.25 on the first trading day of 2021 to $347.51 earlier this week. That’s an increase of about 1,900%.
Such a meteoric rise is unheard of in the stock market. Sure, Tesla (Nasdaq: TSLA) is up 643% over the past year, which itself is a moonshot for any stock and a windfall for early investors in the electric vehicle maker. But the rise of GameStop stock over less than a month dwarfs Tesla’s performance.
In addition, GameStop is by all accounts a small company when you look at its sales and earnings numbers. The retailer of video games is also struggling financially. Sales are falling at a 30% annual rate.
Thus the question on everyone’s lips this week, why did GameStop stock rise in this way, and can it be sustained?
The Story Behind the GameStop Stock Rise
GameStop (NYSE: GME) is primarily a bricks-and-mortar video game retailer with more than 5,000 stores. But this business model is frowned upon by many in the investment community due to both long-term and short-term factors. Long-term, fewer and fewer gamers actually journey out to physical stores to purchase their games. Instead, they download them. Short-term, the COVID pandemic has kept and continues to keep shoppers away from all types of retail locations.
GameStop has suffered massively from these negative trends. And some have begun to consider it a dying business. In the third quarter of 2020 (the most recent reported), sales were about $1 billion, down 30% from the same quarter in 2019. The company had a net loss of $18.8 million, or 0.29 per share. As a result of results like that, GameStop stock had been drifting lower for years. It was around $56 a share in late 2013, but had fallen to under $4 by March of 2020.
Of course, that was before the massive surge.
So why did GameStop stock rise the way it did this month?
Well, it’s about much more than this one small and somewhat insignificant stock. It’s about the little guys – retail investors trading on Robinhood and other stock trading apps – trying to outsmart the big guys – the hedge funds and other institutional investors.
Rarely can small-time retail investors outduel the big institutions. They just don’t have the firepower in terms of capital, technology, and other resources. This time, however, the little guys seem to have won – at least for a brief moment.
A Comeback Story
Despite GameStop’s bleak outlook, last year a well-known investor named Ryan Cohen increased his holdings of GameStop stock to more than 10% of the company, with hopes of transforming the mainly physical retailer into more of an online player. Lots of small investors – presumably many of them gamers themselves with an affinity for the video game retailer – latched onto this comeback tale and bought in.
But then the hedge funds got involved. Several major hedge funds looked at GameStop’s books and decided that the company was doomed to fail eventually. So they bet against GameStop stock by shorting it. That means they borrowed the stock and sold it, hoping to buy it back later (and return it to the stock lender) after the stock price fell. It’s the equivalent of buying low and selling high, just in reverse order.
Retail investors resented this, apparently. And they began to take their revenge. These small investors collaborated (in a legal way) on discussion sites like Reddit to bid up the price of GameStop stock. This sent the stock price up rapidly and created what is called a short squeeze. Institutions that were “short” the stock found themselves squeezed because they needed to return the shares they had borrowed and sold.
So, the institutions had to purchase GameStop in the market, at market prices. All that buying just sent GameStop stock up higher – creating a vicious circle for the short-selling hedge funds. And now you know the answer to the big question, “why did GameStop stock rise so fast?”
In fact, one hedge fund called Melvin Capital lost so much money on its GameStop short positions that it needed a capital infusion of nearly $3 billion to shore up its finances.
And GameStop isn’t the only stock that has seen this kind of tug of war between retail investors and hedge funds lately. A few others include:
- Blackberry (NYSE: BB)
- AMC Entertainment (NYSE: AMC)
- Bed Bath & Beyond (Nasdaq: BBBY)
Can The GameStop Stock Surge Last?
Can it last? Well, in the long-run, fundamentals – sales and earnings – drive stock prices, despite wars between the longs and the shorts, the believers and the naysayers. And no matter what the price of GameStop stock indicates, its fundamentals – and its future prospects – remain iffy, at best.
As Chief Investment Expert Alexander Green wrote yesterday, “I won’t predict whether the [GameStop] bubble bursts this week, next week or next month, because it isn’t possible to make rational projections about when irrational behavior will end. But end it will.”
And you can gain more insight from Alexander Green by signing up for the Liberty Through Wealth e-letter below. His team provides daily stock analysis and tips for building wealth in your life.
In fact, the eventual fall of GameStop stock may have already begun. The stock was down more than 29% Thursday. Whether the little guys can bid it back up remains to be seen.
But if you’ve been asking, why did GameStop stock rise the way it did, now you know. And you might also know it’s probably a stock to be avoided.
About Matt Benjamin
Matt has worked as an editorial consultant to the International Monetary Fund, the World Bank, the Economist Intelligence Unit and other global macro-institutions. He wrote about markets and economics for U.S. News & World Report, Bloomberg News and Investor’s Business Daily, among other publications. He also worked for several years as head of political economy for a Financial Times-owned macroeconomic consulting firm, advising hedge funds around the world. Matt’s claim to fame is that he’s interviewed two U.S. presidents and has spoken with five Federal Reserve Chairs from Paul Volcker through Jerome Powell. Matt also served as The Oxford Club’s Editorial Director for two years.