The meme stock phenomenon returned after Keith Gill (aka Roaring Kitty) posted on X, formerly Twitter, a meme related to GameStop (GME) on Sunday May 12th. GME, after closing at $17.46 the previous Friday, opened higher on Monday and the fever continued into Tuesday with the stock peaking above $55. After nearly returning to pre-meme levels over the next two weeks, GME popped again Tuesday the 28th after announcing a $933M equity offering. This offering diluted existing shareholders and is like the $500M and $1B equity offerings executed during the previous meme fervor in 2021. Neither offering changed the direction of the company- total free cash flow since is negative $760M. This most recent offering still generated enough excitement to drive the stock price up about 25%.

This gamification of the market is not good for the overall perception of the market or the long-term investor, regardless of whether GME is a good or bad investment. It increases the perception that the market can be a “get-rich-quick” scheme. Wait until the right moment, invest all your money, and see it more than double in a couple of days. While this can happen to a lucky few, it is not a smart strategy. The strongest driver of stock returns is earnings growth, and companies generally cannot double their earnings in a couple of days.

The meme stock phenomenon also increases the perception that the market is rigged. A few insiders know what’s going to happen, and everyone else is left behind. There are market insiders- for example, executives at public companies know what earnings will be before they’re released. This is why there are strict rules around insider trading and quiet periods around earnings to prevent a select few getting information before it’s widely distributed. This system is not perfect, but it is not rigged.

These market movements also increase the perception that the market is like betting with winners and losers. Betting is a zero-sum game, meaning that if one person bets $100 Team A will win, another person must lose $100 if Team A wins, with the total sum being $0. This is not the process for buying and selling stocks. If an investor sells 100 shares of Microsoft, that investor receives the dollar value of the 100 shares while the buyer now owns 100 shares. It is an exchange of goods, analogous to buying a house, car or even groceries. After buying a gallon of milk, no consumer goes home thinking they’ve bet on milk. The difference between milk and Microsoft is obviously that Microsoft is an investment with long-term appreciation potential. Milk is a product that must be consumed, or it goes bad.

One lesson from the meme stocks is not to buy based on speculation. In other words, don’t buy a stock just because you believe someone will pay more for it tomorrow. While that is the goal of any investment, speculation is based on hope. Investing is based on fundamental research that shows the stock will appreciate over time, e.g. by growing its earnings. As Benjamin Graham, the “father of value investing,” said, “In the short run, the market is a voting machine but in the long run, it is a weighing machine.”

The volatility of GME may be a fun news story, but it’s not part of a long-term investment strategy. Meme stocks should not result in lost confidence in the long-term potential of the market and its ability to grow wealth.

For more background on shorting stocks see our February 2021 blog, published shortly after the original meme craze: SHORT SQUEEZES IN THE MARKETS.