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2021 saw the emergence of meme stocks as Reddit users orchestrated a short squeeze that skyrocketed the price of GameStop Corp (GME) stock. Now, the OG meme stock is back in action. The price of GameStop stock rose dramatically (74.4%) on Monday, May 13, coinciding with Keith Gill’s (also known as “Roaring Kitty”) return on social media. Being meme stocks, AMC Entertainment Holdings Inc (AMC) and BlackBerry Ltd (BB) also experienced major positive momentum last week following GameStop’s gains.

To understand the complex nature of meme stocks, we must look into the history of the meme stock concept and what is happening in the companies behind meme stocks.

The Emergence: What Happened In 2021?

When the first frenzy started in early 2021, investors were mostly at home because of the pandemic and had excess money through larger savings. Generally speaking, those circumstances no longer exist. The fact that interest rates were at all-time lows might also have contributed to the rise of meme stock mania back in 2021. Despite its high risk, trading stocks would have seemed like a means to make money because holding on to cash gave very little to nothing in the way of a return.

In his letter to Berkshire Hathaway stockholders in 2023, renowned investor Warren Buffett remarked:

For whatever reason, markets now exhibit far more casino-like behavior than they did when I was young… The casino now resides in many homes and daily tempts the occupants.

– Berkshire Hathaway shareholder letter (2023)

The rise of zero-fee retail brokerages and risk-taking social media investing forums also seems to be intimately linked to this phenomenon known as “meme asset wagering.” Ultimately, the basic human temptation of making something big, social media hype, and the fear of losing opportunities were the main reasons that drove the prices of meme stocks higher in 2021.

What’s Up With The Companies Behind Meme Stocks?

GameStop is the infamous meme stock. Though the company is experiencing a price hike currently, the company’s strategy is antiquated; it is more like Blockbuster than Netflix. While they may invest in other businesses, their core function is facing difficulties. Even though the company turned profitable in FY 2023 with a net income of $6.1 million, the company’s total revenue for the respective period declined by 11% to $5.27 billion.

The positive net income was achieved by cutting costs rather than improving the top line. The company might not be able to survive despite its newfound focus on collectibles, as the revenue from collectibles shrank by 21.8% during the last financial year. GameStop has a presence in the U.S., Canada, Australia, and Europe. During the past fiscal year, the company’s store count has declined, especially in Europe, where the number of stores went down from 829 to 647 (22%). It seems like an understatement to claim that GameStop’s core business is struggling.

Exhibit 1: GameStop’s Annual Revenue and Net Income

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In Q1, EPS ($0.21) and revenue ($1,793.6 million) fell short of what analysts had projected. Both software and hardware for video games experienced a sales decline (19.4% decline year-on-year). This is probably a result of more individuals purchasing video games online rather than in physical stores, making the future of GameStop uncertain at best.

When looking into AMC, although the company’s revenue is predicted to rise in 2024 (total revenue grew by 23% to $4,812.6 million in FY 2023), the business is still losing money, even though it is less than the previous year (net loss improved from $973.6 million to $396.6 million in FY 2023).   

Exhibit 2: AMC’s Quarterly Revenue and Net Income

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On April 29, 2024, the price of AMC’s stock fell by 11.1%, the most since early April following its preliminary first-quarter results. The company attributes the drop in movie ticket sales to the strikes that occurred in Hollywood the previous year. AMC claims that despite the decline, its sales, profits, and earnings per share for the quarter were all higher than anticipated. They anticipate that box office sales will continue to improve all year. However, analysts advise against purchasing AMC stock, highlighting that the business model of the company AMC is antiquated and does not reflect the current trends in entertainment consumption, which is similar to GameStop.

Why Investors Should Avoid Meme Stocks

A recent study on meme assets by Kahlil S. Philander suggests that meme assets are a new trend in risk-taking. Investors who take part in this trend feel less vulnerable to financial volatility and tend to be overconfident in their capacity to make investments. Additionally, meme asset owners experience gambling issues, proving that meme stocks are not financially logical options but rather a gambling impulse.

Even though there is a chance for significant profits in the short run, the risks associated with meme stocks should not be disregarded. Focusing primarily on retail investors, these stocks are very volatile and unpredictable, typically driven more by hype and social media frenzy than by basic business fundamentals. Meme stocks often are driven by short squeezes, in which short sellers are compelled to repurchase shares at inflated costs, therefore pushing up the price.

The fear of missing out can sometimes push retail investors to bet their money on these meme stocks. However, it is important to keep in mind that meme stocks do not represent reliable businesses.

Takeaway

If investing successfully in stocks was as easy as following a subreddit to jump on the latest meme stock, it would have been difficult to lose money in the market. With reality being far from this, retail investors need to distance themselves from get-rich-quick means such as investing in meme stocks and focus on fundamentally strong companies trading at a discount in the market. Avoiding losses in the market is as important as finding good companies to invest in, and meme stocks should be avoided at all costs regardless of their appeal and past heroics.

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