MC Explains | All you need to know — the what, how and why of Meme Stocks

What are meme stocks?

While the name may suggest that these stocks are fake, they are, in fact, actual shares of listed companies and businesses in the US. What makes them meme stocks is the hype, mainly on social media, that pushes up their value far beyond their underlying fundamentals — by 30 percent to 50 percent overnight.

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When retailer GameStop was written off in January 2021, a group of Reddit users banded together to “buy up stocks and drive up value”  flummoxing fund managers’ short strategies. What started as an experiment to take the company against Wall Street expectations ended in a bubble burst that forced regulators to step in and left a few richer and many high and dry.

Case in point: A 20-year-old college student made $110 million by selling his stake in Bed Bath & Beyond as the company’s stock price rose over the summer. Jake Freeman’s big pay out possible because he sold his Bed Bath & Beyond shares before billionaire investor Ryan Cohen exited the struggling home goods retailer following a stunning rally in the meme stock this month.

Thus, while meme cryptocurrencies (see Shiba Inu and Dogecoin) may not have intrinsic value, meme stocks are shares of actual companies that are inflated beyond their real worth by social media hype.

How do meme stocks gain steam?

So, what drives this over-inflated worth? It is a combination of hype and the fear of missing out (FOMO) among investors who either don’t mind the high risk or are not fully aware of the risks of buying into the hype.

Social media is a key player. In the case of GameStop, the buyer mania started on Reddit. Word of mouth and company names trending over their “surging values” expose more investors to stocks they may usually not have considered.

Also Read | Meme-stock frenzy returns, baffling Wall Street’s ‘smart guys’

As the name suggests, memes and hype push the stock to the notice of retail investors and it gains momentum via social media frenzy. Such surges largely buck Wall Street and institutional diktats to result in a “financial coup.” Online forums seek to “game the system” and “beat them at their own game” to pull unlikely winners out the hat.

The pandemic also played a part, with many small investors at home and able to trade with the convenience of mobile apps such as Robinhood. Online communities banded together to bring down the establishment and play them at their own game.

But what about the post-pandemic surge? Well, more retail investors are now trading online through apps and have the ability to coordinate online. These investors seek to either “teach a lesson” to rich Wall Street investors who short companies or support businesses that had been written off by hedge funds, all while making gains.

Another factor is that lately, speculative investors and individuals with high risk appetite are fuelling the resurgence of meme stocks, deeming it worth the risk to make big bucks by betting against hedge funds.

This suggests that as more trading moves online, meme stocks will continue.

How is Wall Street affected?

Well, they are certainly confused. As Mark Taylor, a sales trader at Mirabaud Securities told Bloomberg, “The ‘smart guys’ are confused, baffled and fighting short positions from a position of weakness in terms of momentum and firepower.

Also Read | College student makes $110 million selling Bed Bath & Beyond's meme-stock

Well, they are certainly confused. As Mark Taylor, a sales trader at Mirabaud Securities, told Bloomberg, “The ‘smart guys’ are confused, baffled and fighting short positions from a position of weakness in terms of momentum and firepower.”

Quincy Krosby, chief global strategist at LPL Financial, noted that retail traders have to “move quickly, because one headline can change the entire trajectory of the stock market.”

Krosby added that retail traders “are daring the Fed and they’re daring some professional investors, and they’re doing well so far” but cautioned that the situation is “dicey because it can go in the other direction really fast.”

Are all meme stocks worthless?

Not all, but real opportunities are few and far between and parsing real winners over the hype is a difficult call. What genuinely interested investors can look for is a company’s story and long-term possibilities. For example, Hertz overcame bankruptcy with its value intact, rewarding investors who stayed put.

DataTrek’s Nicholas Colas noted that at some point, “most companies will fail or dramatically underperform” but there would certainly be some winners among the disruptors.

Even in the short term, a basket of meme stocks tracked by Bloomberg in August rose 3.7 percent, extending a six-day rally. Among the group’s top performers were GameStop and Express Inc.

To be fair, early investors who got in on GameStop and AMC before the mania took hold at the start of last year are sitting on hefty paper gains. Both stocks are up more than 350 percent from the start of 2021; however, they’re down 73 percent and 81 percent from their 2021 highs.