The Capitalist Investor - Episode 60

What is happening in the stock market with GameStop and AMC? Is it good? Should it be happening? Is it even legal? In this episode of The Capitalist Investor, we dissect what’s happening and why it could be dangerous for the average retail investor.

Outline of This Episode

  • [1:10] The background on GameStop and AMC
  • [4:20] The lowdown on short-sellers
  • [11:11] Why this is so dangerous for the retail investor
  • [13:56] It’s a pump and dump scheme
  • [18:19] What is the stock actually worth?

The background on GameStop and AMC

To understand why what’s happening is dangerous, you have to understand the basics of these companies. GameStop stock is a dead stock. The company is on the verge of bankruptcy because it hasn’t evolved. Yet the stock is up hundreds of percent.

AMC was filing for bankruptcy at the end of 2020. As of the date of recording, AMC is up 232% at $16.50. Bed Bath & Beyond is skyrocketing. They’ve even got Blackberry rising. Why? Because of the people trading stock ideas on this Reddit board.

How the Reddit mob is toppling hedge funds

You have big-time short sellers who will issue a report showing that they are short a position because they have a valid reason to short the stock. It’s usually based on the fundamentals of the business (i.e. they’re going broke).

Shorting a stock means that you are selling a stock that you don’t own. You borrow it from someone else and sell it. If you sell it at $50 and it topples to $20 and you rebuy it, you covered the trade and made $30. The downside is that your losses are infinite. Why? Because the stock price can rise infinitely.

This Reddit message board decided to buy the companies where there was high short interest. The retail investors have no fundamental or technical reason for doing this. That doesn’t mean this Reddit thread didn’t have reasons.

First, they want to make a profit. The leader on the site has made about $50 million out of $50,000. Secondly, they want to “stick it to the man,” which they’ve done by bankrupting numerous hedge funds. Lastly, they’re trying to “save” the companies they want to.

But pumping their stock price up doesn’t save the company. The billionaire shorting a stock and talking about the short position in his portfolio has technical reasons for doing so. There is no fundamental case for owning GameStop. It’s a dangerous play and many don’t know what they’re doing.

Why this is so dangerous for the retail investor

Why is buying and driving up the price of these stocks so dangerous? If a stock like GameStop goes from $30 to $300 it’s artificially inflated. The stock isn’t worth that amount. How are they going to monetize those profits? The only way to profit is to sell. Once this Reddit thread decides to liquidate, who is going to buy what they’re selling? Nobody.

It’s a game of hot potato. If you get out now before everyone decides to sell, then you made some money. But a lot of people will be left holding the bag. I’m concerned for the Robinhood investors who are going to lose their shirts when they all sell. These aren’t buy-and-hold companies. The bottom line? If a message board gives advice, it’s likely only benefiting them.

How is it different from a pump and dump scheme?

You can’t legally pump and dump stock. I can’t go on TV and pump a stock and get off-air and sell it. As a professional, you can’t rally the troops to do one thing then take the other side of the bet. What’s the difference between a professional on TV and a dude running a message board to get people to buy GameStop? They both have influence. It’s about how far your influence goes.

Derek believes in the last six months people have learned that you can pump money into the stock market and get rich in three weeks. 2020 has been so easy for a Robinhood trader. You can show up late to anything and make money. But the momentum trade will end and it will end poorly. 

The market is volatile and in dangerous conditions right now. Is what you’re buying right now worth the money? I feel bad for the people that bought high after it crashes. Don’t be the one left holding the bag.

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Keep Listening to The Capitalist Investor:
Episode 13:
Fireside Chat with a Firefighter, Ep #13
Episode 29:
Is a Vacation Home an Investment? Ep #29
Episode 45:
Spooky Stocks: Proceed with Caution, Ep #45
Episode 61:
Special Episode: The Super Bowl Indicator, Ep #61
Episode 14:
Positioning Your Portfolio During A Recession, Ep #14
Episode 30:
The “New Normal” Investing Playbook, Ep #30
Episode 46:
Red or Blue, These Stocks are Tried and True, Ep #46
Episode 62:
6 Actionable Lessons for Investors, Ep #62