GIULIETTA TALEVI: GameStop, and how Robinhood toppled Wall Street
As far as the wider market is concerned, more than a few folk are becoming jittery over sky-high valuations, given the bewildering gains we have seen in recent months
If you’re looking for a real-life example where the good guys win and the baddies get busted, then steer clear of the State Security Agency, and the revelations of industrial-scale theft coming thick and fast from the Zondo commission.
We’re not talking Monopoly money here. Or maybe we are. That an astonishing R9bn could disappear, with nary a receipt in sight, suggests that no-one in the agency, or former president Jacob Zuma’s cabinet, or President Cyril Ramaphosa’s, for that matter (oh, hello there, deputy human settlements minister David Mahlobo!), would know the difference between the value of Monopoly money and an actual rand.
R9bn is, after all, a lot of zeros.
There is one tale, however, that involves both Monopoly-money crazy and underdogs sticking it to the man: the spectacle now playing out between retail day traders and short sellers over a once moribund company called GameStop.
Chances are you’ve probably never heard of it. GameStop is a US bricks-and-mortar video games retailer, the sort you’d think got left behind by the Amazons of this world. In 2019, it made a loss of $795m and was described as a “failing mall-based retailer”.
But this shabby relic has now become one of the hottest punts on Wall Street, having risen a barely conceivable 1,500% this year. And yet, it’s also the most shorted stock out there, as investment experts have been betting for some time that it would collapse entirely.
Well, The Verge explains in this article that because of lockdowns, “many people are at home and bored, and consequently, interest in day trading has shot through the roof. There is a Reddit forum for this, r/WallStreetBets.”
About a year ago, one user of that forum, delaneydi, argued that GameStop was underpriced by the market, and that everyone should buy it.
“For a while, the idea that r/WallStreetBets would take over GameStop was a joke — but then it turned serious. The idea was to punish short sellers, and for the little guys to pummel Wall Street,” the article says.
By buying into GameStop en masse, the small day traders have caused the stop to soar — giving them the added joy of turning the screws on the smart guys on Wall Street, who’d expected GameStop to plunge.
And yet the resulting 1,500% rise in GameStop’s shares this year is, in no small part, due to how short-selling works.
BBC Business has a great explainer on the tale, as well as the principle behind short-selling in this article.
“Key to what’s going on is ‘shorting’, where, say, a hedge fund borrows shares in a company from other investors in the belief that the price of the stock is going to fall. The hedge fund sells the shares on the markets at, for example, $10 each, waits until they fall to $5, and buys them back. The borrowed shares are returned to the original owner, and the hedge fund pockets a profit. That’s the somewhat simplistic theory, anyway.”
But this theory all falls apart when, as with GameStop, the share price actually rises instead. In that case, the hedge fund still has to return the shares it borrowed, but to buy them back first, it now has to pay, say, $20 for shares it sold for $10. Now, it makes a sharp loss.
So with GameStop, the hedge funds have been hammered. So much, in fact, that this saga has now claimed its first major scalp: that of highly regarded hedge fund Melvin Capital.
Jitters rise over sky-high valuations
“The Reddit jockeys,” writes The New York Times here, “have toppled a bigwig. Gabe Plotkin, the hedge fund trader whose Melvin Capital was shorting GameStop — and who recently raised a $2.75bn bailout from Citadel and his former boss, Steve Cohen, amid the short squeeze — confirmed to CNBC that he was throwing in the towel and had exited his position.”
It’s not as if Melvin Capital was a greenhorn in the hedge fund industry. The company has about $12.5bn in assets under management and gained 52% on its market calls last year. But its bet against GameStop has cost it a cool $3.75bn — and this in just three weeks.
For spectacle, this one is hard to beat. But as far as the wider market is concerned, more than a few folk are becoming jittery over sky-high valuations.
There issue is now, writes the Financial Times in this article, “dividing Wall Street between those warning of a ‘bubble’ and those questioning traditional assumptions about how best to value a business”.
The FT even has a series called Runaway Markets, dedicated to the bewildering gains we have seen in recent months. Take Tesla, for example.
“Tesla,” it writes, “was a red-hot stock even before the coronavirus crisis, boasting a forward p:e ratio — a common measure of the value the market puts on a business’s future profits — of 75 times at the start of 2020. That was the highest of any company worth more than $50bn, according to Bloomberg data.”
But, over the past year, the equation has changed as the share prices of “new technology companies” have soared, seemingly becoming entirely detached from the underlying profits. Now, 29 big companies are trading on even higher valuations (on a p:e basis) than Tesla was. And Tesla’s shares today are trading at 209 times its expected earnings.
The FT quoted one European hedge fund manager as saying: “Nobody cares if you’re profitable these days — who are you, Graham and Dodd?”
(Benjamin Graham and David Dodd are regarded as the founders of value investing, using p:e ratios to sniff out stocks undervalued by the market.)
Profit? Such a quaint notion today. Rather like receipts or an honest government, in fact.
*Talevi is the FM's Money & Investing editor.
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