Meme stocks can cost you a lot of money

An analysis of the share price of popular meme stocks shows that dabbling in them is dangerous and can destroy your wealth if you do not time the market correctly.

The term ‘meme stock’ first gained prevalence in 2021 with a company called GameStop, the world’s largest video game retailer.

It became public knowledge that several hedge funds had significant short positions on the company’s stock.

Hedge funds took short positions because they believed that brick-and-mortar video game stores would die a slow death due to their outdated format.

140% of GameStop’s free-floating shares were sold short, which shows the imbalance in the stock.

A group of retail investors, aware of the significant short positions on Gamestop, organized a short squeeze on the stock.

A short squeeze occurs when an unexpected price increase occurs. Short sellers scramble to buy back the shares they borrowed to avoid even bigger losses.

This sudden surge in buyback activity further pushes the price up, creating a snowball effect, which causes the share price to rise rapidly to unrealistic levels.

Retail investors realised they could trigger a short squeeze on these hedge funds by collectively starting a buying rally.

By buying the stock, retail investors could drive up the share price, forcing entities with short positions to close out their short positions at significant losses.

During this period, GameStop’s share price soared to obscene levels, causing significant losses to many hedge funds. It even caused one to shut down.

Retail investors pitted themselves against large hedge funds and manipulated the market to their rules.

The GameStop valuation became detached from the company’s fundamentals and only rallied on the immense social media following and hype.

Subsequently, after the hype died down, GameStop’s value fell back to more realistic levels and is now way off from where it traded at its peak.

Many retail investors lost money as they bought the stock at ridiculous valuations in the hope that the rapid rise would continue.

The term “meme stock” was subsequently used to describe any stock that became popular on social media that would surge in price beyond levels that fundamentals could explain.

GameStop is not the only example, and a short squeeze is not the only reason why these stocks’ share prices can rise to ridiculous levels.

In the case of Zoom, the share reached a peak of over $550 on the back of the pandemic when work-from-home became the norm.

Zoom recently traded at a new all-time low. The share price is down 90% from its peak in October 2020.

Investment analyst Charlie Bilello highlighted that Zoom’s revenues have increased over ten times since its IPO in April 2019. However, the stock price is lower today than back then.

“How is that possible? High starting valuation and multiple compression. It was trading at 50x sales 5 years ago, growth slowed, and it now trades at 4x sales,” he explained.

What the GameStop and Zoom examples show is that the share price typically reverts to its fundamentals.

The corrections with GameStop and Zoom are not unique – they happen with basically all meme stocks.

Investors should, therefore, be cautious when stocks are heavily promoted on social media. Make sure the company’s performance justifies the share price.

Just because a company’s share price keeps increasing does not mean that price is justified.

The graph below shows the current return of some high-profile meme stocks from their high points.

Company name	Ticker
Blackberry	BB
Gamestop	GME
Opendoor Technologies	OPEN
New Concept Energy	GBR
Beyond Meat	BYND
Tilray Brands	TLRY
Clover Health Investments	CLOV
Koss Corporation	KOSS
Virgin Galactic Holdings	SPCE
AMC Entertainment Holdings	AMC
Express	EXPR