Yahoo Finance What is GameStop and should you buy stock?
An extraordinary battle of wills is taking place over GameStop, a hitherto unglamourous and perhaps failing retailer of video games and consumer electronics.
In the blue corner are powerful Wall Street hedge funds. In the red, amateur day traders on a mission to stick it to the man via Reddit and other sites. It is the Internet vs Wall Street.
If you believe some of the chatter, the world of investing will never be the same again. The people have spoken and delivered a message to the financial elite.
What has happened at GameStop?
An army of small investors, seemingly, set out to disrupt plans by hedge funds to force the shares down. The hedge funds took the view that the business was devastated by Covid and out dated anyway. It would surely fail.
The stock had plunged to $3.25 each last year. Then a well-known investor called Ryan Cohen took a 13% stake with a plan to shake-up the business. The shares began to soar as small investors typically trading on apps such a Robinhood bet the company would recover. That put them in opposition to the hedge funds going “short” on the stock. The shares boomed in extraordinary ways, leaving the hedge funds nursing losses in the billions. Today the stock is at $347.
What is shorting?
An example: I think shares in Company X are overvalued. I reckon they will halve from £1 each to 50p. I go to a pension fund and borrow 1 million shares in Company X from them for a month, paying the fund a fee for its trouble.
I sell those shares, pocketing £1 million. At the end of the month, I buy those shares back and return them to the pension fund. If I was right and they did indeed halve to 50p, I have made £500,000, less fees.
If I am wrong and they actually doubled to £2 each, it costs me £2 million to buy them back. Which means I am down £1 million. And probably out of a job.
What is a short-squeeze?
To stick with the above example, when shares in Company X start rising my short position looks vulnerable. I am worried I am going to be out of pocket, so I start buying the shares. That in turn has the effect of sending them still further upwards. I am short and being squeezed.
Should short selling be banned?
Absolutely not. There is nothing wrong with betting against a company’s shares. It can act as a sort of warning to other investors that all may not be well. Shorting can be a bit destabilising of a company in the short-term, but in the longer-term Company X only goes bust if that was what was going to happen anyway.
Is GameStop really worth that much?
It is awfully hard to see how. At a market value of nearly £18 billion it would be the 30th biggest stock in the FTSE 100, just above Associated British Food, the giant which owns Primark and British Sugar.
As Russ Mould of AJ Bell notes, before the pandemic ABF was making profits of £1 billion a year. Gamestop makes losses, not profits.
Should I be in any way sorry for the hedge funds?
You should not and are not.
How does this end?
Badly, for some. There is this idea that the GameStop story fits in with wider public anger at large institutions, that it is some sort of protest like the Brexit vote, a way of folk taking back control.
Maybe. Or maybe it is just this blip that will soon be forgotten.
Could it happen in the UK?
Day trading is bigger in the US, there is more of a culture of ordinary folk playing markets. But no reason in principal why not. There has lately been a flood of new, inexperienced investors opening share accounts for the first time. Perhaps some of them might decide the City of London needs to be taught a lesson…
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