I’m sure many of our clients have been following the news regarding the highly unusual trading activity in companies such as GameStop, AMC Entertainment, Bed Bath & Beyond, and even Tootsie Roll. Given how much of the news cycle has been consumed by this activity, I thought it warranted some quick commentary. Let’s use GameStop as an example.

GameStop is, at the time of writing, a failing business with an outdated model. GameStop has seen large losses and declining revenue; prior to this month’s activity, its stock price had been declining for some time along with its operating results. Investors looking at the state of GameStop have three options: sell your shares, don’t buy any more shares, or short the shares.

Let’s focus on shorting. If someone wanted to profit from the decline of GameStop’s business, they could borrow the shares and sell them short. Selling short means that you’d borrow the shares, sell them in to the market, and hope to return them to the lender at a lower price than you sold them for and you’d pocket the difference as profit. The practice of shorting is relatively simple in concept (but also very high risk) and plays a necessary role in the market, but sometimes it’s more complicated than that.

Here's what happened: overzealous short sellers got aggressive, and had large short positions in these companies – in fact, the amount of shares sold short in GameStop was larger than the entire float of available shares. It sounds crazy, but it does happen sometimes. In comes an internet forum known for high risk trading who, to their credit, saw this as an opportunity. Collectively, tens of thousands of small traders began buying shares in the struggling business. Shortly after, it’s likely that some large institutions and professional traders began working the same trade. However, there isn’t any evidence that most of these traders were purchasing shares because they believed in a future turnaround, but rather to “squeeze” short sellers out of their position. The objective was to start to increase the shares price through a massive buying push which would then force short sellers to cover their positions in order to prevent significant losses. The act of covering these positions creates significant additional buying demand which drives the share price even higher.

The fact GameStop has risen roughly 1,700% in less than a month is truly astounding but has clearly been independent of the fundamentals of the company. It’s important to keep in mind that trading and investing are not the same thing.

So, is GameStop really worth $18 Billion USD?

No, clearly not. But, for this brief and peculiar moment it is – at least, on paper. We are currently watching this unfold from a distance. We understand the factors that have caused this ridiculous event and wait with interest to see the fallout. Make no mistake, it’s likely that this will end sooner rather than later and these stocks will return to a realistic price that is more closely connected with their deteriorating businesses.

If you have any questions, please connect with us any time.