What can we learn from the GameStop phenomenon?
My introductory article is actually that of an associate of mine. Contact information contained at the bottom. Without further ado…
GameStop stock (GME) has been all the rage recently. It seems like everyone has had an opinion on it, from comedians decrying broken capitalism to billionaires praising the fighting masses. So what really happened, and why? Did GameStop show something fundamentally wrong with our economy or the stock market? I think that answering these questions can provide a nice introduction to the type of content and reasoning that you will find in my publications on this site. I will, of course, write a standard introduction article next (titled “What is value investing?” or some clickbait-heavy variation) that goes through all of the things I think are important for understanding my market analysis. GameStop is more fun though, so let’s talk about that first.
Think about GameStop the business. When was the last time you bought something from a GameStop? What is your impression of it? My guess is that you probably think that GameStop, like most brick-and-mortar retail stores, is a dying business. I would imagine that most people think that, because it seems to be correct: according to its public filings, GameStop has not made a yearly profit since 2017. The business has been hemorrhaging cash in recent years, and the ongoing COVID pandemic and lockdowns surely are not helping.
In spite of this general negative sentiment, the price for one share of GameStop was as high as $483 during the chaos of the last month. What does this really mean? The stock price of a company is just a convenient way to talk about the value of the business. To buy a publicly listed company and become the sole owner, you just have to buy all of the outstanding stock at the current market price (obviously this is a crazy simplification of a buyout, but it works for our purposes). When share prices were at their high-water mark, the entire company of GameStop was worth north of $30 billion. For comparison, in June 2020, GameStop was worth about one hundred times less. This seven-month variation in valuation happened despite the company acknowledging that there was no undisclosed material reason for the rise.
We have learned two things so far from the above paragraph: 1.) stock prices are just proxies for business valuations and 2.) business valuations (and thus stock prices) can fluctuate by orders of magnitude for no “material” reason. One conclusion people have taken from these two truths is that capitalism/money/the market/stocks/wealth is fake (no really, you can find plenty of blog posts and articles like this one doing just that). I find it hilarious that these people are totally right, but also fundamentally wrong at the same time.
Let me elaborate with a slight digression. Let’s say I have a car that you want. It is a nice car that I know has value, so I will not just give it to you for free. If you really want the car, there are only two ways for you to get it. The first way is for you to steal the car from me. After you do this, you have the car and I have nothing - you won this interaction and I lost it. Your situation is materially better, while mine is materially worse. The second way for you to get the car is through a transaction. For me to agree to give you the car, you have to offer me something that I value more than the car - I would never agree to a trade that I thought I was losing. Let’s say you offer me $10,000, and I accept the trade. Implicit in this transaction is that you value the car more than $10,000, because you would also never agree to a trade that you thought you were losing. At the end of this second scenario, you have gained something that you valued more than the cash you had and I have gained something that I valued more than the car I had. We both won the interaction and have materially benefited from it.
The above example of buying a car beautifully illustrates why I think capitalism is objectively a good and moral system. Capitalism is the second scenario, where you buy the car. Pure capitalism is a market where all of the interactions between people are of the second type, which I call capitalist transactions. These types of exchanges are positive-sum (both participants benefit from the transaction, creating some “value”), whereas the theft illustrated in the first type of interaction is zero sum (one participant benefits, but the other loses the same amount of value as the first gains). If you now imagine iterating this process, having large numbers of these positive-sum transactions every day, you should be able to see how value builds up in a capitalist society. The natural state of capitalism is growth.
Back to GameStop. What does my digression have to do with anything? Every time someone bought a share of GameStop (at, say, $483), they were engaging in a positive-sum capitalist transaction. The buyer valued 1 share of GameStop more than $483, and the seller valued $483 more than their one share. The buying and selling of GameStop shares, and thus the large increase in GameStop’s share price, was a result of mutually beneficial capitalist transactions1. Despite how out-of-control the situation seemed to the average person, capitalist market dynamics was in the driver’s seat the whole time.
Everyone who said the GameStop saga proved that capitalism/the market was broken, then, is fundamentally wrong. We just showed that the market was functioning as it should by facilitating capitalist transactions. Let’s now show in what way some of their critiques are right. In a capitalist transaction, a trade happens that benefits both parties. Nowhere does capitalism say what should be traded so that both parties benefit. Going back to our example from above, you paid $10,000 for my car. The people who decided that $10,000 was the right number for you to pay were you and me alone: you decided that it was the right amount to offer, and I decided that I would accept. No one else had any say. Whenever you see that a GameStop share sold for a certain dollar price, you must remember that this sale is an agreement between two people. The price they agreed to is impacted by all of the whims and subjectivity that you would expect any agreement between two people to be affected by. Most importantly, any idea you (or anyone else) have for what the price of a GameStop share should be doesn’t matter. The jaded twenty-something socialist bloggers are right: prices are “fake.” An asset is worth exactly what someone will pay for it, regardless of whatever you think of that price.
The run-up in GameStop’s share price was fueled by loads of buyers willing to pay higher prices for shares: the demand for GameStop stock soared. Since the supply of shares stayed more-or-less constant, it only makes sense that the price went up. Of course, these people all eventually sold their shares as well, leading to the subsequent collapse in price that we have seen.
Let’s step back from the specifics of the GameStop saga and look at the bigger picture that we have painted now. GameStop stock went up and down as a result of normal demand/supply dynamics because of capitalist transactions made freely by market participants. There is nothing wrong with this -everyone who bought did so because they valued the share more than their money, and everyone who sold wanted the money more than the share2. However, there were probably many people who lost loads of money buying high and selling low. Thinking now about all the money I have saved up over the years, I personally would hate to lose it doing something like buying GameStop stock at $483 per share only to turn around and sell it at $50 per share. Maybe you think the same. So how can I avoid getting myself into that scenario? What are the tools that I can use to make sure I am buying low and selling high? Enter value investing.
Value investing is an old school of thought that claims business valuations based on fundamentals can tell you something about stock prices. According to those whopopularized it, it does deliver returns. This claim may not make sense based on our discussion above: if the price of a commodity is based on nothing more than two people’s agreement, how can value investing have any hope of working? The answer is simple: if most/all of the participants in a particular market think it works, then it will work; if they don’t, then it won’t. Let’s consider an example. Look at Tesla stock (TSLA). There has been a large movement, called TSLAQ3, to short the stock due to its lack of profitability and high valuation (Tesla is currently the most valuable car company in the world despite only being able to eke out profits over the last year or so). Sure, the TSLAQ movement has a point, but the market for Tesla stock does not care. The stock has continued to increase in price. Tesla short sellers have been massively burned over the last year, to the point where I would imagine most have given up on actually maintaining a short position. The trick to value investing, then, is finding the right markets to enter. These markets will be ones where value investing principles still seem to hold. In my trading, I try to find these opportunities and play them profitably. This site will be my attempt to document my work and thoughts while I navigate the wild economy of 2021 and beyond.
If you have enjoyed this piece and want to join me on my journey, I hope that you will join my mailing list. It is free to join. There is also a paid tier where I will be keeping most of my trading logs and other cool stuff; I have a 30 day free trial link for it below. I am trying to grow my audience, so if you could share this piece with your friends who might like it I would be forever grateful.
Credit: The Intrinsic Value Report; Published 12 February 2021.
https://intrinsicvaluereport.substack.com/p/introduction-gamestop?r=gcdvi&utm_campaign=post&utm_medium=web&utm_source=twitter
Commentary from The Daily Spread:
First and foremost, this is a well written article by the individuals over at The Intrinsic Value Report. The Daily Spread focuses on the method of Swing Trading using oscillators but for those that are interested in long term value investing, head on over to The Intrinsic Value Report for more information (read the disclaimer both here and there).