Your Financial Future: Explaining the Game Stop stock surge
The national news has been filled with stories about Game Stop. Since the beginning of January the price has exploded 鈥� by some reports the stock price has been up 2000%.
How does this happen and is this a good investment for you to buy?
Let蘑菇视频 look at the fundamentals: Game Stop has been in existence since it was founded in 1984 as Babbage蘑菇视频. They sell video games and consoles. One of the things that made them different was they would also sell used video games. Maybe a new game would sell for $60. You could buy that at Game Stop. They might have a used copy of the same game for $30. They bought the used game off of a consumer who either got tired of the game or didn鈥檛 enjoy playing it. Often the seller would purchase a new game while they were in the store. Many of Game Stops brick and mortar stores were located in shopping malls.
The company was performing, but not very well. For six straight years the stock price went down. In 2019, they closed 321 stores. While not released yet, total store closures for 2020 were expected to be more. In 2020, the company lost $165.7 million dollars and the stock was selling for about $6 per share.
There are serious questions if they will go bankrupt. Streaming is becoming a bigger part of the gaming industries and some of the newer games that come on disk cannot be reused as often as before. This makes reselling used games less profitable. Many malls are also hurting. This does not seem to be a company you would want to invest in for the long term.
With this terrible outlook you would never think you would see the returns that the stock produced in January. Hedge Funds are very large corporate investors. They make some investments 鈥渓ong鈥� which means that they like most investors think the price will go up. Unlike most investors they also invest 鈥渟hort鈥� which means they think prices of the stock will go down. The hedge funds believe, maybe rightly so, that Game Stop was not a viable business.
When you short sell a company, you pay a fee and borrow stock from a broker. You expect to replace the borrowed shares when you buy them back at a lower price when the stock tanks. This is how you make a profit. One social media platform saw the huge short positions in the stock and got many of their followers to buy. Most of the purchasers were day traders not investors. As their money poured into the stock, the price rose quickly. All stocks rise when more people want to buy and go down when more people want to sell.
This situation was compounded because all of the hedge funds were getting squeezed as the price went up. They had to buy shares because they must maintain certain margins in relation to the borrowed stock and try to lower their risk. This made the price go up faster. It is estimated that hedge funds have lost $20 billion on paper.
One of the ironic things about this stock run up is the company is not any stronger today than it was last year. They do not receive these inflated stock prices because they go to the investors. This phenomenon will end when the hedge funds have covered their shorts. They will have no interest in owning a money-losing stock at unrealistic values. Whoever owns the shares at that time will have to take a huge loss because no one will be willing to buy at those inflated values. The stock will probably end up somewhere close to its value when this whole thing started. This is not the kind of speculation most investors should engage in, and certainly not risk their retirement savings.
Next week, we will discuss some other valuations in the stock market.
Your Financial Future is written by certified financial planner Gary W. Boatman, MBA and CFP, who also wrote the book, 鈥淵our Financial Compass: Safe Passage Through The Turbulent Waters of Taxes, Income Planning and Market Volatility.鈥� If there is an area that you would like to see discussed in the column, send your suggestions to gary@BoatmanWealthManagement.com.