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The madness surrounding GameStop in early 2021 captured the imagination of both professional/institutional investors (“smart money”) and amateur/retail investors (“dumb money”) alike, as the price surged from $18.84 (unadjusted for a 4-for-1 stock split in July 2022) at the start of January and briefly touched $483 later that month, a gain of about 2,500%.
The movie “Dumb Money” (co-starring Seth Rogan as evil short-seller/Wall Street tycoon Gabe Plotkin of hedge fund Melvin Capital and based on the previously published “The Antisocial Network” by Ben Mezrich) tells the story of how a “ragtag group of amateur traders” was supposedly successful in “bringing Wall Street to its knees.” “Dumb Money” is a morality play writ large, with both David vs. Goliath and Good vs. Evil served up in the form of over-the-top caricatures of struggling individual investors and Wall Street “fat cats” (no pun intended).
We’re unabashedly “old school” investors who view stocks as ownership interests in the underlying business (not just ticker symbols traded millions of times a day) and value stocks based on future profitability (not what we think the next “sucker” will pay for it). “Dumb Money” is a theatrical dramatization of a social-media-fueled frenzy and attempts to capture the same type of rage that led to the Occupy Wall Street movement in 2011.
Although it paints a “French Revolution”-style takedown of Wall Street and populist victory by Reddit’s WallStreetBets crowd, the actual events were far less enchanting.
Briefly, some multibillion-dollar hedge funds (lightly regulated investment pools) built massive short positions in GameStop, betting the price would fall. Plotkin’s investment thesis was that game consoles were migrating to “disc-less” formats (with games purchased online) and GameStop was the next Blockbuster Video.
When you buy stock in XYZ, you have a “long” position and profit if the price increases. Your upside is theoretically unlimited, and the worst you can do is lose 100% of your investment. Conversely, you can “sell short” stock in XYZ. You arrange with a broker to borrow shares, sell the shares and lastly return the shares (“cover the short” by repurchasing the shares) at a future date. Importantly, you also deposit 150% of the proceeds with the broker as collateral. You profit if the price declines (because you repurchase the shares at a lower price). The best you can do is make 100% on your investment (the stock goes to $0), and your downside is theoretically unlimited.
A “short squeeze” occurs when the stock price rises rapidly. The broker that loaned the stock will demand more collateral as the stock price rises (the dreaded “margin call”). You can either deliver the additional collateral or cover your short. Buying to cover short positions adds even more upward pressure on the stock price, leading to a melt-UP in price and even more pain.
Plotkin sold GameStop short in 2014 (when GME was in the $40s) and seemed vindicated as the stock crumbled to $4 to $5. There is an old investing adage: “Bulls and bears make money, but pigs get slaughtered.” Unfortunately for Plotkin, so many other “smart money” investors made the same bet against GameStop, the stock’s short position expanded to an insane 140% of its outstanding shares (all of which would eventually need to be repurchased), creating a powder keg. Indeed, Plotkin rode his “short” from $40 to $4 (a gain of 90%) but holding on for the last 10% proved his undoing.
Every revolution needs a folk hero, and Kenneth Gill, using the nom de guerre of “Roaring Kitty” on YouTube and “DeepF—ingValue” on WSB, fit perfectly. Gill was a chartered financial analyst (CFA—like both of us), so he had legitimate securities analyst chops. He first purchased GameStop in June 2019 (stock around $6), investing his entire $53,000 life savings. Gill posted his thesis that GameStop was undervalued because investors were 1) underestimating the prospects of its legacy business, 2) overestimating the likelihood of bankruptcy and 3) ignoring its potential to reinvent itself as the ultimate destination for gamers.
Around the same time, Michael Burry of The Big Short fame (he correctly bet on the bursting of the housing bubble that led to the global financial crisis in 2007-2008) announced he had accumulated a large position in GameStop and penned three public letters to management exorcising them for mismanaging the business and not repurchasing stock.
On Nov. 16, 2020, Ryan Cohen, co-founder of pet e-commerce company Chewy, disclosed he owned 9.98% of GME and demanded that management transform GameStop into a gaming e-commerce company. GameStop relented and announced on Jan. 11, 2021, that it was adding Cohen and two associates to its board.
The Reddit army seized on the positives promoted by Roaring Kitty/DeepF—ingValue, Burry and Cohen and coalesced around the idea that coordinated buying of GameStop would cause the stock price to leap, a “short squeeze” would ensue, and major pain would be inflicted on the evil hedge funds.
These were generally younger folks who had experienced three cataclysmic events in just 20 years (9/11, the Great Financial Crisis and COVID), so it’s easy to see how a nihilistic, “We’re all going to die anyway”/”YOLO” mentality took hold. In fact, these “expressive traders” are not motivated by profit alone, but trade as a form of social protest, political speech or aesthetic expression, especially when egged-on by the likes of Elon Musk and Mark Cuban.
“Peak crazy” occurred on Jan. 28, as Robinhood incited investor fury when it halted buying in GameStop. The Davids saw Robinhood colluding with the Goliaths, which were being pummeled and not subject to any trading restrictions. In fact, it got so surreal that U.S. Rep. Alexandria Ocasio-Cortez, D-New York, and U.S. Sen. Ted Cruz, R-Texas, actually agreed Robinhood’s action was “unacceptable” and that congressional hearings were warranted.
The House Financial Services Committee held three hearings. The title of its report, “Game Stopped: How the Meme Stock Market Event Exposed Troubling Business Practices, Inadequate Risk Management and the Need for Legislative and Regulatory Reform,” summed up its non-shocking findings. Much to the chagrin of the conspiracy theorists, no plot by Goliath to cheat David was uncovered.
Melvin Capital started 2021 with $12 billion in assets, lost $6.8 billion in January and announced in May 2022 it was closing. Robinhood CEO Vlad Tenev revealed in his testimony that half its customers were first-time investors (median age 31), with median and average account size of $240 and $5,000, respectively. With that limited firepower, we think it’s more likely it was other Goliaths like high-frequency trading firms and other hedge funds that turned David’s “playing with matches” into a raging inferno.
You get on a roller coaster for the thrill of the ride, not to get somewhere. Gill’s initial $53,000 investment briefly hit $48 million, but nobody knows if he had “paper hands” and sold or “diamond hands” and held. As to “Dumb Money,” his testimony said it all. “Social media platforms like YouTube, Twitter and WallStreetBets on Reddit are leveling the playing field. And in a year of quarantines and COVID, engaging with other investors on social media was a safe way to socialize. We had fun.”•
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Kim and Lee are chief operating/compliance officer and director of research, respectively, for Columbus-based investment adviser Kirr Marbach & Co. They can be reached at 812-376-9444 or mickey@kirrmar.com and roger@kirrmar.com.
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