Following the rise to fame of ‘meme stocks’ made famous by the edgy subreddit r/wallstreetbets, renowned investor Michael Burry has raised concerns and described a massive ‘bubble’ in meme stocks. Burry who previously won big by betting against CDOs in the GFC speculates a bubble in order of magnitude of the dotcom crash and GFC. This is the great Meme Stock Bubble.
The renowned investor Michael Burry who recently caught media attention with the hype around an Index Fund Bubble was originally all for the rise of meme stocks like Gamestop but has since backflipped on this.
His private investment firm bought a stake in the video-game retailer Gamestop in 2019 and owned a massive 1.7 million shares as of the end of September 2020.
The renowned investor is pointing at meme stocks as clear signs of rampant speculation in recent times. Here’s why…
What is a Meme Stock?
“Meme Stock” is a new phrase that is used to describe a very actively traded stock that has been publicized by social media.
Nasdaq defines it as: With meme stocks meaning stocks that see sudden and dramatic surges thanks to social media hype.
Meme stocks are often volatile, and will often trade on volume and technicals rather than fundamentals. The growth of the meme stock movement continues to gain momentum and has allured in a lot of investors to the lucrative returns. The stocks are fuelled by sentiment, hype, and FOMO.
The latest Meme Stocks:
- GameStop Corporation
- AMC Entertainment Holdings Inc.
- Clover Health Investments Corporation
- Virgin Galactic Holdings Inc.
What does this Mean for Meme Stock Companies?
Having their share price pumped massively is big news for an ailing businesses like GameStop or AMC. This allows the company to raise capital through the issuance of shares at massively inflated prices. Using this capital they can reinvest into the growth of the business.
“This is a Godsend for these companies”Michael Burry
Gamestop was able to raise over $1.6 billion in capital from share sales in the first six months of this year.
The Full Meme Stock Index
We can see across the board the index is up 792%. This was based on an initial purchase date of 25/07/2020, 1-year prior to the time of writing, $10k or as close as possible was theoretically purchased in each stock.
GameStop Stock is the most talked-about stock of 2021. The story behind the famous short-squeeze is a once-in-a-lifetime opportunity that made a number of everyday investors very rich and nearly brought down Wall Street.
The famous GameStop Short-Squeeze commenced in January 2021. This initial spike sent the share price rocketing with a massive 2,741% jump over a month. The 52-week range of the company is 3.77-483 (a difference of 12711.67%).
GameStop Corp is the world’s largest video game and entertainment software retailer. They are a Fortune 500 company with 53,000 employees and $5 Billion in revenues last year.
Tesla is often forgotten about as a “meme stock” but in our eyes, it matches the criteria perfectly. It is a very actively traded stock that is constantly publicized by social and general media. One thing that’s different about Tesla is the duration of its publicity. For years Tesla has been in the news for scandals and advancements. Elon Musk himself has been excellent publicity for the company and arguably the reason behind their media success.
Due to this, we do see Tesla as a meme stock, but also as a company that we don’t see losing the spotlight any time soon.
Arguments For The Meme Bubble
Meme Stocks are Massively Overvalued
From this data in terms of the three most basic forms of valuation, all these popular meme stocks are massively overvalued.
Price to Earnings Ratio (PE): PE is the most basic valuation metric of a company. The PE ratio can be interpreted as the amount you pay for $1 in company profits.
A company with a high PE could be seen as overvalued or that investors are expecting large growth in the future, they can also be seen as riskier. A company with no profits will not have a PE, or may be expressed as a negative PE.
We can see all these Meme Stocks fit in the following two categories:
Price/Book: is the market cap of the business divided by the book value. As such it represents the valuation of the company in relation to its assets. We can see Gamestop, and Tesla appears grossly overvalued in terms of book value, and AMC has a negative book value.
Return on Equity (ROE): Return on equity (ROE) is a measure of financial performance calculated by dividing net income by shareholders’ equity. ROE measures how many dollars of profit are generated for each dollar of shareholder’s equity. We like companies with consistently higher ROE over 10. A low ROE means low growth potential. We can see all of these companies have either a low or negative ROE.
How Overvalued are Meme Stocks?
Based on the basic fundamentals we can see they deviate massively from the market averages. Across all categories, these stocks on average deviate from the standards by a massive 602%.
The Sentiment is Running Out:
Originally the meme stock Gamespot started out as a largely undervalued company that was massively shorted. This lead to the great GME short-squeeze. Read through our analysis here. However, with the widespread coverage, there were many more people jumping aboard in FOMO. With so many investors rushing to the stock it’s easy to see how this catalyzed a massive spike. Arguably it wasn’t the short squeeze that rocketed the price, it was the media hype.
This is what we’re seeing for a lot of these meme stocks, there is often an underlying story that drives the initial interest, but after this, the price is driven solely by momentum, hype, and FOMO.
As interest begins to taper we expect to see the volumes and prices of these companies begin to return to fundamentals.
“We’re running out of new money available to jump on the bandwagon”
When married up with google trends data we do see that interest is driving the share price increased.
Arguments Against The Meme Bubble
The Next Big Crash…Again
Something to consider is that every year some big famous investor is calling the next big crash. Sure, one day one of them will be right. But until that time history has shown that good financial markets will continue to make excellent returns.
“Meme Stock” is a Broad Phrase:
As mentioned earlier the term meme phrase doesn’t have a set definition. Just because a stock becomes actively traded after being publicized by social media, doesn’t mean it is destined to pop. Publicizing a company isn’t a new concept. The market is unpredictable. Sometimes the company may have solid underlying fundamentals. Or those that don’t may continue to shoot up in share price.
This is something we saw from tesla. Arguably one of the first meme stocks there shares price has continued to perform strongly despite a disconnect from underlying earnings.
It is possible to make money off these stocks. Keep in mind what sort of investor you want to be, create your own goals and figure out what works for you.
Meme Stock Won’t Bring Down the Global Economy:
Burry quoted some pretty massive relations to the dot-com crash and GFC. Both of which caused devastating stock market crashes. I don’t see meme stocks having the ability to cause mass crashes across the entire market. Instead, I see this playing out as the simple return of many of these stocks to their intrinsic valuations over time, with the remainder of the market left unimpacted.
Michael Burry Meme Stock Bubble: The House of Cards
The overinflated meme stock index can be likened to a house of cards, with no solid foundations.
“All hype/speculation is doing is drawing in retail before the mother of all crashes. #FOMO Parabolas don’t resolve sideways; When crypto falls from trillions, or meme stocks fall from tens of billions, #MainStreet losses will approach the size of countries. History ain’t changed.” Michael Burry
Prophet’s Take: Summary on the Meme Stock Bubble
We have had to disagree with some of Burry’s bold bubble claims in the past, most notably his attack on the index sector, but when it comes to ignoring fundamentals and trading on hype we have to agree with Michael Burry on the Meme stock bubble.
All this is not to say Meme stocks can’t be a solid trading strategy. It is possible to make money off these stocks. Many people have made a lot from trading these stocks already, and I believe there’s is still a lot to be made going forwards. But for us, it doesn’t match our investing strategy. Keep in mind what sort of investor you want to be, create your own goals and figure out what works for you.
For this reason, we do a careful thorough due diligence on all stock we invest in and ensure their underlying business is solid and not prone to a pump-and-dump, check out how we analyze stock here.