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GameStop, Monkey Stocks and All Hail the Memer Investor

Founder, Ilipsis Digital
Jun 5, 2021 10:23 AM 11 min read

In January this year, I was looking at memes on Reddit researching on the latest trends in value investing when I came across this meme —

I dug myself into a rabbit hole to find out that GameStop — an American video game, console and merchandise retailer — had become one of the world’s richest companies, pretty much overnight, because a group of spiteful redditors wanted to get back at Wall Street.

What?

Yes. Let’s take a minute to process this. If you are old enough, you might remember a store called Planet M where you could go and buy music CDs, cassettes and merchandise in physical form maybe about 20 years ago. We don’t see any Planet M stores anymore because we don’t buy physical CDs and music cassettes anymore. Now, Imagine if you read a front page headline in the Wall Street Journal in 2021 that says “Planet M surpasses Tata Motors in market capitalisation, thanks to millennials uniting on a certain social platform.”

(The above is a made up headline) ;)

Well, that’s pretty much what happened to GameStop. A small group of hedge funds wanted to short its stock, and a larger group of millennial kids doing "timepass" on Reddit and having a little disposable income in their pockets along with an app on their smartphones that let them trade stocks, decided to squeeze the hedge funds from their shorts.

I could probably paraphrase ‘squeeze the hedge funds from their shorts’ better, but I’m going to keep the double entendre.

What is shorting?

Shorting is basically betting against something when everyone else is betting on it. For example, if everyone else thinks that a certain premier league team will absolutely decimate the league but I think that Sunrisers Hyderabad will win instead, I am effectively shorting the other team. Or, when my valuation of the Tesla stock came to $10.66 when it was trading at $624, you could say that I was technically trying to short it (lol).

As in both these cases, a rational investor such as you, the reader, will probably think “wow, this guy is an absolute daft; he must be an MBA”. And you’d be right about 99% of the time. Except when you’re not.

So, how do hedge funds short? Simple example — When lockdowns started, the demand for hand sanitisers started increasing. There are two types of sanitisers: Alcohol-based and non-alcohol based ‘herbal sanitisers’. There’s an equal demand for both initially because people just want a sanitiser.

Now, one Arjun fellow, the smartest and top-looking indie consultant in Hyderabad, thinks that non-alcoholic herbal sanitisers are not going to last long, so he decides to short them. In March, he goes to the distributors of these herbal sanitisers and borrows from them 1000 bottles of the herbal sanitiser for a few months with a promise of returning 1000 bottles of the herbal sanitiser back to them on a certain date in the future. He then goes and sells all these herbal sanitisers in the open market at the prevailing price of, say, ₹100 per bottle. So, if he sells 1,000 bottles, he gets Rs 100,000.

Come April, say, the WHO releases a report saying that only alcohol based sanitisers are effective in killing a certain type of virus and all these herbal sanitisers are just meh. This leads all buyers of herbal sanitisers to panic and rush to sell their stockpile to anyone who is willing to buy. The price of herbal sanitiser drops to ₹25 per bottle.

Enters Arjun again, and says “Okay, I’ll buy 1,000 bottles at ₹25 per bottle” and does it. What a saviour! Someone should endorse him on LinkedIn.

So, Arjun buys 1,000 bottles by paying ₹(25 x 1000) = ₹25,000 from the ₹100,000 he had collected earlier, returns the 1000 bottles that he borrowed from the distributors back to them and pockets a net ₹75,000 to buy an iPad Pro for himself.

(I am very smart!)

But shorting something has one very peculiar characteristic which makes it a very risky manoeuvre. See, when I’m ‘longing’ something (which is the opposite of shorting), my loss is limited to the price I paid for that thing. If I bought a bottle of the herbal sanitiser for ₹100, the maximum money I can lose on it is ₹100, whereas the maximum profit I can make on it is, technically, infinite. Who knows, the price of one bottle of herbal sanitiser can climb up to ₹1,000 in a few weeks, or maybe ₹5,000. But when I’m shorting the herbal sanitiser, the maximum profit I can make is ₹100, while the maximum loss I can make is, well, technically, infinite.

Shorting works on the principle that I am borrowing the herbal sanitiser from the distributors, and I have an obligation to return the 1,000 bottles back to them. When I don’t have any stock (because I previously sold all the borrowed 1,000 bottles, I have to buy them back in order to return them to the distributors. If my short fails, that is, if the price of the sanitiser is > ₹100 when I’m buying it back, I’m making a loss. If the price is ₹1,000, I’m losing ₹900,000. If the price is ₹5,000, I’m losing ₹4,900,000. There’s literally no limit on how much money I can lose here.

And, for buying the herbal sanitisers back from the market, I need someone who is willing to sell it to me.

 

In comes the short-squeeze

Say, there’s a group of people who own these herbal sanitisers. They see that I’m shorting these and they collectively decide not to sell their sanitisers come what may. This could be for any reason. Maybe they really like herbal sanitisers. Maybe they don’t like hedge funds. Maybe they are just envious of my perfectly chiseled bod.

So, these envious folks start making TikToks about how cool herbal sanitisers are. This creates a hype for herbal sanitisers in the market. A certain Mr. Leon Mask tweets “👍🏻'' alongside a picture of the bottle and all hell breaks loose. The demand for herbal sanitiser shoots up like my blood pressure does when I read a certain Ranaut’s tweets. And since these folks have hoarded the supply and refuse to sell, the price of the herbal sanitiser hits ₹10,000 in a few hours.

For me, the shorter, the sanitiser just became the sataniser. My loss on an investment of ₹100,000 is ₹9,900,000. I go and file for bankruptcy and start writing a book hoping that some movie producer will make a biopic on me someday. Till then, I’ll just have to settle for turning into an eternal meme material.

Now, replace the herbal sanitiser in the above story with GameStop, replace Arjun with a Hedge Fund called Melvin Capital, and replace the envious folks with Reddit memers — and that’s what happened in January 2021.

Since then, there have been a couple of other companies that have seen their stocks shoot up because of memer investors — AMC, the theatre company; or Hertz, the car rental company.

There is one more player in the entire GameStop saga that I haven’t spoken about yet — Robinhood — the essential trading app for small investors. Like its namesake, the legendary outlaw that took from the riches and gave to the poor, Robinhood intended to democratise investing for small investors by not charging any commission for executing their trades. The average account size on Robinhood is around $1,000 - $5,000. That’s not a lot to move a stock.

Unless you have 13 million users on your app.

And these users were peasants in front of the big Wall Street hedge funds. So, obviously, Robinhood came to their rescue, took money from the evil streeters and gave it to the peasants.

LOL. JK. Robinhood rushed to restrict its users from trading GameStop.

(Source: @overratedcomic)

So here’s what I’ve been thinking about:

 

Are meme stocks really a value investment?

That’s questionable. There hasn’t been a very strong precedent for researchers to study this, presumably because they are busy doing actual research instead of browsing Reddit like this guy. Observationally, meme stocks are driven by social media hype and behavioural economics instead of the traditional growth and value narratives cited in seminal investing books that we’ve all read two chapters of. It’s okay to have an emotional connection with something — I loved my Blackberry in 2010. But, would I invest my money in Blackberry in 2021? I’ll leave this open ended.

Is it wrong to short? And Is it right to short-squeeze?

No, I don’t think so. Shorting is not just about speculation. It’s also about conviction as Dr. Michael Burry from the movie ‘The Big Short’ would like us all to believe. Shorting is a way of de-risking yourself. When your bank asks you to get a term insurance against a long term loan, it’s essentially shorting you and hedging its risk against you not being able to pay it back. You know what kind of funds hedge?

Gee, I wish there was a clue somewhere.

Likewise, I don’t think it is wrong to short squeeze either. Shorters often get it wrong. People (like the aforementioned Dr. Burry) want to short Tesla. But they’ve lost their money so far. And that’s in part because of a natural squeeze by Tesla investors who don’t want to sell their stock — and not because some guy working there went on the Joe Rogan podcast to get the good stuff.

 

So, what would you do if you suddenly became rich?

GameStop literally won a jackpot. But what should it do with all this money especially when everyone knows that their bloated valuation is not because of the nature of their business, but more in part due to high flying post-adolescent emotions.

I’ve read that GameStop is planning to invest the money in an NFT. I don’t know whether that’s a good idea, especially when alternatives such as RTGS and UPI are easily available these days. My wife made this joke, albeit unintentionally, but I thought it was absolutely bonkers.

Anyway, I’ve heard that GameStop is planning to invest the money in Non Fungible Tokens, or NFTs. I don’t think it’s a bad idea. Gaming has interesting use cases for NFTs and this would also allow GameStop to stay aligned to its roots in gaming. But I don’t think they have a solid defence here. Maybe they’re late to the party.

But it’s a fair question for an investor to ask whether she would get a better return on her investment here than the next fellow? For delivering higher returns to your investors, you need to take higher risks. You know, like shorting a bunch of stocks.

Has anyone run this through the GameStop management?

 

Is the memer investor smarter than the hedge funds?

I’ve written about this before. With the GameStop saga, the entire media narrative was made around a David vs Goliath story — Big hedge funds vs small investors. But if you think about it intuitively, who do the hedge funds work for? They work for investors (maybe not as small, but investors regardless).

When a small investor invests, they are thinking “Will I get a decent return on my investment here?” They’ll do the groundwork themselves, which mostly consists of asking their friends “bro where should I invest before I file my 80C on Tuesday?”

Whereas, an investor at a hedge fund asks the fund manager “where are you going to invest my money to give me a higher return than the next fund manager, because if you can’t do that, I’m taking my money to the next guy/gal.”

Me and my questionably smart friends have spent days trying to figure out effective ETF portfolio strategies while lounging on the Bloomberg terminal and reading Barron’s to sound intelligent at alumni networking events. We read through digests of financial statements, post mortised P/E ratios, dividend yields and whatnots, sliced data in deciles, ran multi-factor regressions and decimated the excel solver to effectively realise that the index funds have pretty much outperformed anything magical that we could have come up with.

(Side note: Between this and my Tesla valuation of $10.66 per share, I am convinced about a very bright future for myself as a finance bro.)

In reality, most investing happens due to FOMO. And most retail investing definitely happens due to FOMO. Eventually, it’s not David vs Goliath. It’s analysts vs the contrarians. And each is trying to short the other.

(PS: Arjun is the founder of the indie consulting firm Ilipsis Digital (www.ilipsis.io), which has been rated Hyderabad’s top consulting firm by Arjun’s wife and mother. His practice focuses around executing high signal strategic consults and executive sparring sessions to early stage startup founders in emerging sectors such as Gaming, Legal, Real Estate, e-commerce, ad tech and HR.

In his career spanning over 13 years, Arjun has held leadership roles at Dentsu, Appcoach, Affinity and Airnow, where he made a lot of decks and deflected many problems by liberally quoting phrases like “state of the industry”.

(Just kidding. He did quite well).

Arjun runs the investor connect at the India Game Developer Conference (IGDC) and helps VCs discover interesting early stage companies and deal flows.

Arjun has an MBA from Indian School of Business and an M. Tech from DAVV.)

FIN.
 

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