As you know, most of my teaching and writing these days is focused on leadership, values and ethics, and what it takes to become a values-based leader and lead a values-based organization.
Nonetheless, since I started out my career in finance and was the CFO of Baxter International before becoming the Chairman and CEO, I LOVE discussing financial topics!!!!
I was recently asked by a former student: “Professor Kraemer, can you explain what is going on with GameStop’s stock?” I was happy to address his question — with several caveats. First, as usual, I have very few answers, but MANY opinions. Second, I try to keep my ego in check, so to assume I know where the stock goes from here is probably crazy. Third, to be clear, remember the fine print on offering prospectuses: “Past performance is no indicator of future performance.” 😉 and fourth, I always try to keep things simple so I don’t confuse myself. 😉
In the case of trying to explain what is going on with GameStop’s stock, rather than focusing on the underlying financial issues, my opinion is that most of the media reporting is far too focused on discussing Reddit, WallStreetBeats, unethical hedge funds, a populist uprising against Wall Street, “David vs. Goliath”, etc. While this makes for headlines and interesting reading, I think a better place to start is understanding and applying several basic finance principles.
So, let’s start with a short financial primer on how the stock market functions based on the training I received from my fantastic Kellogg financial professors (Dean Don Jacobs, Stuart Greenbaum and Eugene Lerner). What I was taught, and continue to believe, is that the price of any stock “over time” is a function of investor expectations, an aggregation of all opinions in the marketplace. I include “over time” because crazy things can occur in the short term. Benjamin Graham, considered the father of value investing, was quoted as saying, “In the short run, the market is a voting machine, but in the long run, it is a weighing machine.”
Let’s use an example: If a stock is trading at $20 per share, at that moment in time there is an equal probability the stock will go up or down. If people think the stock will increase, they may buy the stock or purchase call options, and if people think the stock will decline, they may sell the stock, short the stock, or purchase put options.
So, in simple terms, here’s my opinion of what happened to GameStop’s stock. The stock price last summer was trading around $6 per share, and given the company’s mediocre outlook for growth and returns, that appeared to be a reasonable price. So what happened? Ryan Cohen, a successful entrepreneur of online pet food company Chewy, purchased 13% of GameStop with the intention of getting a seat on the GameStop board and moving GameStop from a mall-based retailer to an internet player. The increase in expectations resulted in the stock increasing by December 2020 to $18.84 per share. But here is where it got interesting. The stock continued to rise, and as it did, several hedge funds decided it was overvalued and shorted the stock. However, retail investors continued to purchase the stock, further increasing the price, and causing a short squeeze (in which the short sellers had to purchase the stock to cover their short positions, further increasing the stock). In fact, the stock got as high as $483 per share two weeks ago.
Yes, some GameStop shareholders had a fascinating short-term run. However, does this significant increase in GameStop stock make economic sense beyond several weeks of frenetic buying and covering short positions? If the market over time is a “weighing machine”, and represents an aggregation of all opinions, how long can this continue? The answer is not very long. In the past two weeks the stock has declined from $483 per share to a closing price on Friday of $63.77 per share — a decline of more than 80%!!! Said another way, GameStop’s market capitalization fell from $25 billion to $4 billion, quickly erasing $21 billion in temporary value!
The question that many folks are asking this weekend as they prepare for Monday’s opening is “where does GameStop stock go from here?” As I said earlier, anything can happen over the short run, but here’s a question worth a little self reflection (you know I would sooner or later bring up “self reflection 😉 ): With very little new information regarding the company’s future growth and returns, does it make sense for a stock that was trading at $6 per share five months ago to continue to trade at $63.77 per share?? I will let you decide the answer to that question.
Interesting article Harry but I still do not like the practice buying long and short. I have bought good companies that have gone out of business only because some guy or group decided to artificially make the company look bad so they could benefit from the losses. Who need these longs and shorts???? I hope they get outlawed.