By Isabel Phua & Fang Wei
If you’ve ever dreamt of becoming a millionaire by 30 without participating in pyramid schemes or attending sketchy workshops about getting rich quick, then you’re in luck! Just buy some stocks recommended by redditors or TikTok financial gurus and wait for them to skyrocket in price and soar “to the moon”. But the question is, does this always happen?
If you actively invest in stocks or bonds, or seen American video game retailer GameStop in the news, you would have probably encountered the term “meme stock”: a stock that has gone viral online on social media platforms such as Reddit or Twitter. This virality draws the attention (and money) of retail investors — namely, individuals that trade using their own savings — and thus skyrocketing asset prices.
But what does a video game retailer have to do with memes stocks? It started with a group of Reddit users rallying others on subreddit page r/wallstreetbets to short squeeze — a rapid increase in price of a stock owning primarily to short selling, where one borrows an asset to sell — GameStop’s stock. Some may call it a grand crusade to give power to retail investors who tend to be everyday individuals, though others have dubbed it as “bullying” GameStop and other financially vulnerable or unfavourable companies.
While the intentions behind r/wallstreetbets may be genuine, most retail investors do not understand the risks of what they are getting themselves into. Many of the activities led by members of the subreddit are often highly speculative and highly leveraged positions, almost akin to mindless gambling. While it is fun to buy some meme stocks and shout “to the moon”, you should really worry about your bank account before listening to these subreddits, because more likely than not, what goes up probably would come down.
Breaking it Down
Before delving deeper into the issue at hand, let’s first look at the typical life cycle of a meme stock: a major event, such as the Covid-19 pandemic, pushes down the stock price of businesses as people lose confidence in the economy, industry and organisation. Coupled with falling profits, these businesses start to slowly fail, especially those that are unable to adapt to changing demands. Often, institutions like hedge funds exacerbate the problem by short-selling these stocks — essentially betting that the price will go down further due to a downward trend in sales to earn larger profits.
Retail investors on social media notice the double-whammy of cheaply priced stocks and short-selling. They thus hype up these stocks, encouraging each other to purchase them so as to increase the stock price in an effort to “punish” these larger institutions.
As stock prices rise rapidly fueled by the social media craze, other retail investors jump onto the bandwagon for fear of missing out on their chance to make a quick buck, creating a bubble of escalating prices that highly overvalues the company. As the hype falls and interest moves to a different meme stock, savvy retail investors cash out their profits, and the price of the stock falls back closer to baseline, leaving those who are slow divest to bear the loss.
This was exactly what happened to GameStop, which was targeted by hedge funds like Square Capital. GameStop’s stock price rose from around US$4 to $325 in just a span of months, to the incredulity of everyone watching. It has now steadily declined to be priced at US$162 as of Aug 18, and many investors have undoubtedly lost money by trading at its height. Worse still for other meme stocks like American cannabis producer Sundial Growers — a meme stock that peaked in Feb 2021 — whose price increased five-fold, before crashing back down again, almost wiping out all potential gains.
Hypes, Likes, and Upvotes
One large problem with meme stocks is the people they attract. Having originated from channels like r/wallstreetbets on Reddit, their astronomical price increases are based largely on hype and speculation. And as with anything on social media, its virality draws traction to such stock — and the money of retail investors.
Imagine this: a newbie investor starts their own investment journey during the ongoing Covid-19 pandemic as they seek to diversify their income stream. However, with the lack of financial literacy and a rush to create income amidst the background of the worsening economy, they turned to social media platforms for quick and simplified financial advice.
With the hype and continuous bombardment about the potential to become rich overnight by investing in a particular stock, they are blindsided by the allure of meme stocks and invest their savings into it.
With little financial knowledge and being more vulnerable to losses compared to institutional investors who trade using an organisation’s large amounts of cash, this cooks up a devastating catastrophe for them and their wallet. Just a single day with a volatile market can wipe out a retail investor’s entire net worth, something which we’ve seen happen during various financial crises.
With such vulnerability, you would expect retail investors to be more cautious. However, they are more likely to buy into the hype of meme stocks — perhaps because of the potential for quick and large gains, or ironically, they’re just doing it “for the meme”.
Predicting an Uncertain Future
Meme stock buzz can spark anywhere and anytime across the internet, so unless you actively track how many times a stock gets memed (like through this meme stock tracker), chances are, most of us would only hear of it when the trend reaches its peak. However, with little knowledge about the stock or its company, new retail investors may perceive the stock as one with strong potential gains, despite it already being severely over-valued.
Even with their high hopes of a quick return, more often than not, the only direction their newly-bought stock can go is down. As such, if they do not catch on this declining trend and sell off their stocks in time, they may end up making an unexpected loss.
To make matters worse, when a meme stock’s price goes down, it often doesn’t go back up like other stocks from trusted firms such as Google or Microsoft. Unlike these larger companies where there are future opportunities for investors to recoup losses as their company grows, meme stocks are based on hype and trends that eventually die off. It’s unlikely that the stock would ever rise to such high values again, so the losses may be permanent.
Additionally, even if you spend your days scrolling r/wallstreetbets, with so many companies touted as the rocket to the moon plucked out of thin air by Redditors, it may be near impossible to correctly predict which stock will become a full-fledged meme stock. These Reddit-browsing investors hoping to get the first-mover advantage on an “upcoming” meme stock may end up investing in a company they know nothing about, basing it on sheer luck.
And should they board the wrong ship, they may end up investing in a stock that has little chance of rising in price, thus potentially making a loss rather than out-of-this-world gains.
Take the example of Sundial Growers. What does it do? Does it have a sound business model? What does it plan to do for the next year or five? Most retail investors certainly have no clue. Without knowledge about how the business functions, investors are unable to ascertain if they are profitable or able to sustain themselves, thus exposing themselves to the needlessly high risk of losing their money.
Too Big a Bubble?
This speculation without basis alongside the belief that prices will continue increasing indefinitely is the reason for a bubble — when a stock prices continuously rises above its actual value as people believe it would still rise. When it reaches a point where investors who are more knowledgeable about the intrinsic value of the stock determine they ought to sell their stock, this triggers a domino effect where the price tanks, and hence, the bubble bursts. As a retail investor jumps onto highly speculative trends, one runs the risk of throwing money into stocks that are simply a black hole.
Are there signs that an investor should look out for in spotting bubbles that will eventually pop? Definitely.
Take the example of AMC Entertainment Holdings, which has seen its stock rise 2000 per cent since the start of the year. Alarmed by the baseless price increases, the entertainment company warned against the purchase of its own stock as they feared it crashing, leaving investors penniless. Evidently, their board of directors believe that an unsustainable bubble is forming — and when a company warns you about inaccurate stock prices, you ought to be alarmed too.
This trend is eerily similar to previous cases, like the 2000 dotcom bubble’s technology stock price crash. If a trend looks too good to be true, it probably is.
Meme or Just a Dream
All these problems with meme stocks can be boiled down to one core issue — the lack of fundamental analysis of all meme stocks, which dismantles the function of the stock market to correctly price companies.
Theoretically, a company’s stock price should correctly reflect the current monetary or accounting value of the company and projections of future profits, as represented by supply and demand of stocks in the market. Institutional investors and traders generally take a company’s inherent value and match it according to its underlying risks before trading in the market.
A low initial stock price may signal that the business might not be coping well, which should be a warning sign. However, retail investors may not take such analysis into account, but rather focus on the chance for quick profit. Should they persist in trading stocks without such basic education, the future of investing is likely to be more volatile than ever.
Ultimately, retail investors need to do more research about the companies that they are investing in. If you do not understand the business model or any key segments of the business, then is it really a good idea to buy in just because everyone else is doing so? For us, the answer is a clear cut no.
Meme stocks, while looking like fun and games, can actually have dire consequences for those who buy into them blindly.
As bleak as the present is, it can get a lot worse; meme stocks and the social media-isation of investing can have wide-ranging consequences for financial markets.
We’ve already seen how users on social media can manipulate markets during the rise and fall of GameStop’s stocks. Behind the cloak of anonymity that the internet provides — who knows how bigger institutions and organisations can utilise such channels to their advantage? In the future, people working on behalf of institutions may even pose as users to spread rumours and start trends to their benefit in a pump-and-dump scheme — similar to what we’re seeing in the cryptocurrency realm though social media influencers.
So, the next time our dear Elon tweets about a cryptocurrency, stock, or any newfangled financial product he’s into — investor, beware.