Meme stocks are soaring to the moon as diamond hand traders place concentrated bets on a handful of companies. Meme traders scour the internet looking for stocks to buy and promote to more traders. The meme stocks are rising because, well, they're rising.
My wife asked me what a meme stock was at dinner last night, and she rarely asks me about stocks, so I knew the trading frenzy has gone viral. I gave her a short answer with little detail, but I told her I would do a deeper dive to answer her question. So here we go.
A group of traders identifies meme stocks through social media sites like Reddit and WallStreetBets. Reddit describes itself as the front page of the internet, while WallStreetBets is a forum for stock and option trades to pump, er share, ideas. The traders typically target companies with high short interest, like Bed Bath & Beyond or SoFi Technologies.
Why would a company with a high short interest be an attractive target? When traders short a stock, they expect the price to fall, so they sell first, hoping to repurchase it later at a lower price - the short seller profits when stocks drop. Most individuals who short stocks are professional traders, whereas meme traders are primarily retail investors. It's David vs. Goliath. When meme traders start pumping up a stock price, the short sellers must buy back stock to limit their losses, so trading volume explodes as retail traders and short-sellers buy stock. For example, the 10-year average trading volume for AMC Entertainment (AMC) is about 13.5 million shares per day. The trading volume for the last five sessions averaged 571 million shares per day, and it traded more than 750 million shares on Thursday! AMC has 117 million shares outstanding, so it traded nearly five times the number of shares available every day last week.
Meme traders use rocket emojis to inform other traders they expect their stocks to go to the moon. Another symbol for these traders is diamond hands. If you have diamond hands, you're a strong trader with the courage to hold your stock while it's falling. Diamond hand traders unite to try and hold the line as their stocks get battered. On the other hand, if you're weak and sell your stock, you have paper hands, according to the meme traders. I own index funds, and I rarely sell, so I guess I have diamond hands.
However, it's hard to argue with the meme traders because their stocks are soaring. AMC is up 2,160% for the year. GameStop is up 1,220%. BlackBerry and Bed Beth and Beyond are only up 109% and 78%, respectively. Several firms offer zero commission trading like Robinhood and Schwab, which added to the speculation, and the Federal Reserve has been accommodating with a near-zero interest rate policy. If we add COVID, boredom, and a lack of sports to the mix, then you have a perfect cocktail for a trading bubble.
Another characteristic of meme traders is they don't care about a company's financial statement, and it's a good thing because the balance sheets for AMC, GameStop, BlackBerry, and Bed Bath and Beyond are horrible. Here are a few of their combined financial metrics.
- Return on Invested Capital = -43.4%
- Annual Revenue Growth = -32.5%
- 5-Year Revenue Growth = -12.2%
- Profit Margin = -197%
- Operating Margin = -104%
- Employee Growth = -24%
I give credit to the meme traders because they're leveraging the power of social media through Reddit and WallStreetBets to promote their ideas. As a result, social media has leveled the playing field. Before the internet, Wall Street firms like Morgan Stanley, Goldman Sachs, and Merrill Lynch used the press to promote their stocks and offerings. The analyst would promote their ideas on CNBC, Bloomberg, or Fox Business News. Likewise, money managers and professional traders regularly talk their book to sell their ideas. It's not uncommon to watch a segment on CNBC where a trader tells the viewers they bought stocks or options during the show! I used to call this front running, but maybe the rules have changed.
Should you buy meme stocks? If you want to speculate with a small portion of your account, and you can afford to lose the money, then give it a shot. If you decide to trade a few meme stocks, limit your investment to 1% to 3% of your capital. And don't use margin! If you currently own meme stocks, sell some shares to lock in your profits because this won't last.
If you don't want to believe me, here is what the management of AMC recently said about their stock:
"We believe that the recent volatility and our current market prices reflect market and trading dynamics unrelated to our underlying business, or macro or industry fundamentals, and we do not know how long these dynamics will last," AMC said in the filing. "Under the circumstances, we caution you against investing in our Class A common stock, unless you are prepared to incur the risk of losing all or a substantial portion of your investment."
"The game of speculation is the most uniformly fascinating game in the world. But it is not a game for the stupid, the mentally lazy, the person of inferior emotional balance, or the get-rich-quick adventurer. They will die poor." ~ Jesse Livermore
June 5, 2021
Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM's custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.
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