If you pay any attention to the news, you’ve probably seen the name GameStop lately. You can tell there’s a lot of drama going on and something about “the people vs. Wall St.” But the rest is just plain confusing, right? I understand, so let me try to bring some clarity to the situation.
Who’s Who & What’s What
Let’s start by defining the players and some important terms:
GameStop Corp. is an American retailer that sells video games, gaming merchandise, and electronics. Like many brick-and-mortar stores, it struggled to keep up in our modern internet-driven retail environment where Amazon is king and few are willing to drive to a store when they can get the same product from home with the click of a button. Seven years ago, their stock was trading around $50 per share and a year ago it had dropped below $5 per share. And that was before the pandemic even hit.
Hedge funds are managed, pooled investments. They utilize a lot of sophisticated investment techniques to try to make as much money as possible. Because of their complexity, they are not open to the average investor, only high-net-worth investors and institutional investors. A favorite investment strategy of many hedge funds is short selling.
Short Selling Stock
If you think a stock will go up in value, you buy it and hang on to it so that you can sell it at a higher price. What if you think it will go down in value? You short sell it. Selling short is when you sell a borrowed stock in hopes that the price will drop. Then you can buy it back for a lower price and return it to the original owner.
Let me clarify with an example. Stock ABC is selling for $20 but you think the stock will go down in value. You borrow a share with the agreement that you will return it in a month. You sell the share for $20. In a month, the stock is selling for $10. You buy a share for $10 and return it to the one you borrowed it from. What happens with the extra $10 from the original sale? You get to keep it.
What happens if you were wrong and the price goes up after you shorted a stock? You have to buy it back at a higher price in order to return it. If the ABC stock price had gone up to $30 after a month, you would have to buy it for that price and you would lose $10 instead of gaining it.
What’s Happening With GameStop?
That should set the stage for you to understand what is going on right now. GameStop was clearly declining. Understandably, hedge funds started to bet against it and short sell their stock.
But then a group of online investors decided to test the limits of their power. With a “the people vs. Wall St.” attitude, they rallied people to invest in GameStop instead of shying away from it. As more people invested in GameStop, the stock price went up. As hedge fund managers had to buy back the stock they had originally borrowed, the price went up. And the movement picked up steam and price has gone up and up. On April 3, 2020, GameStop stock closed at $2.80 per share. On January 28, 2021, it peaked at $469.42 per share. Their plan worked.
What GameStop Teaches Us About the Stock Market
Like seemingly everything else from the past year, what is going on with GameStop is rather unprecedented. It is fascinating to watch and there is a lot that we can learn from it. Here are a few nuggets of wisdom to chew on:
Stock Market Behavior is Not Always Rational
One of the great fallacies of economics is that people always behave in a rational manner. That simply isn’t true. Any rational investor would have looked at GameStop and seen a bad investment. Those who started buying it to run up the price were instead trying to send a message. Even though now many people who have bought it are primarily doing so to make money, it is unique that there is an alternative motive as well.
How do you know when stock values will be based on a company’s fundamentals and when they will be based on people trying to send a message? You don’t. There’s no way to know which company will be the next GameStop or which currently successful company will be the victim of a devastating social media boycott. While we like to think of the stock market as efficient, those buying and selling in the market every day are humans and don’t always behave as you might expect.
Diversification & Time Protect You From Irrationality
If a dying company’s stock can increase 16,765% in less than a year, how can anyone make sense of the stock market and invest successfully? The key is that GameStop is only one company. Yes, there are several other companies that they are doing the same thing with, like AMC Entertainment. Those are only a few companies out of the thousands of publicly-traded companies in the US.
To avoid having the irrational behavior of one or two stocks throw your whole portfolio off, it’s important to diversify. Having a number of different kinds of stocks and/or bonds will cushion the effect that any single erratic stock can have. As the saying goes, it’s dangerous to put all your eggs in one basket.
In addition to diversification, time is an investor’s friend. How long do you think this GameStop story will last? How long can individual investors prop up a dying company? It might last a month or a year, but probably not 20 years. Stocks can go up and down in a matter of months (Remember last March?), but returns are smoothed out over decades. The stock market may seem crazy at times, but a long time horizon and proper diversification can help you ride out the bumps into a successful future.
There’s Only One Sure Bet: God
A lot of hedge fund managers were betting against GameStop and have lost a lot of money for doing so. Just like twenty years ago when a lot of people were betting their futures on a company called Enron. At Guide Financial Planning, we believe in stock market investing and we believe that most of our clients will be better off in the long run if they invest money in the stock market. But we acknowledge that the stock market is not the be-all and end-all. The stock market is fallible. We know that the only true security is found in Jesus Christ.
If you want a financial partner who shares your trust in God instead of putting all of their faith in a volatile stock market, you’ve come to the right place. Whether you want someone to walk with you through the ups and downs of life or just a one-time meeting for some expert advice, we can help. Schedule your free introductory call today!
About Guide Financial Planning
Guide Financial Planning is led by founder Ben Wacek, who is a Christian fee-only Certified Financial Planner™ and Certified Kingdom Advisor®. He has a passion to help people of all income levels make wise financial decisions and steward their resources from an eternal perspective using Biblical principles. Based in Minneapolis, MN, he works with clients both locally and virtually throughout the country and abroad. You can follow the links to learn more about Guide Financial Planning and our team and the services we offer.