GameStop shares spiked more than 140% Monday, forcing several trading pauses and extending a staggering rally sparked by the passions of retail investors on social media betting against the institutional wisdom of Wall Street.
But that frenzied optimism flipped by late morning, sending the stock briefly into negative territory before it did another U-turn. It was trading up about 12%, around $73 a share, by early afternoon.
The Grapevine-based video game retailer’s stock has soared more than 285% since the beginning of the year, charting an epic run for a brick-and-mortar business that, like other retailers, has seen its customers migrate online, forcing the company to shutter hundreds of stores last year. But unlike many other stocks that have flourished because of the disruptions of the coronavirus pandemic, GameStop’s mind-boggling run has been fueled by a confluence of trading dynamics, pushing the stock price to dizzying heights, largely divorced from the fundamentals of the business.
Short sellers, or investors who had planned to profit from GameStop’s fall, are now paying a hefty price, as the stock has not retreated as they had anticipated, compelling them to purchase GameStop shares at inflated prices to avoid even greater losses.
Here’s what you need to know about GameStop’s stock surge.
Why is GameStop stock rising dramatically?
The start of GameStop’s January rally can be traced back to August 2020, when Ryan Cohen, the co-founder of the online pet supply company Chewy, disclosed that he held a major stake in the company through his investment firm, RC Ventures. With a successful track record in e-commerce, Cohen has since pushed GameStop to move away from emphasizing its physical stores and reorient the business around digital sales, esports, streaming and mobile gaming.
In January, GameStop appointed Cohen and two other former Chewy executives to its board of directors, tasked with accelerating the company’s transformation into a tech-centric e-commerce power house. Shares nearly doubled the week after the announcement.
What does GameStop’s “short squeeze” mean?
Touting the optimistic case for GameStop’s future, and the huge opportunity for gains in a company that many institutional investors had bet against, day traders on Reddit and other online communities snapped up GameStop shares..
Part of GameStop’s tremendous climb is tied to those who believe its shares will sink. At the start of the year, GameStop was among the most highly targeted companies by short sellers - investors who bet against a company and who stand to make money when a stock price falls. To short a company, a seller typically borrows a stock and then sells it, with the intention of buying the stock back at a later date, once the price drops. The seller then returns the shares to the entity from which it borrowed, and pockets the difference in price.
But in cases where the pessimistic bet fails to pan out, and the stock price rises, short sellers still have to cover their borrowed shares and are forced to buy the stock back at the higher price. This is known as a ‘short squeeze.’ In this situation, short sellers move to cut their losses and purchase shares that they expected to fall in value but in fact have risen. This money-losing “squeeze” can fuel a cycle of even higher prices, as short sellers buy more shares and drive costs upward.
How might the stock rebellion end?
“The ‘short squeeze’ story is that shorts think it’s worth $20 or less, so at $25, they pressed, and when the stock went to $30, they covered, driving it to $35, where they shorted again. It’s a vicious (or virtuous) cycle,” said Michael Pachter, an analyst with Wedbush Securities. Pachter noted that roughly one-third of the company’s 65 million outstanding shares are owned by company insiders and activist investors, and that when one of them sells, the “bubble may burst.”
From its lows last April, when GameStop traded at $2.80, shares have risen more than 2,400%.
“The sudden, sharp surge in GameStop’s share price and valuation likely has been fueled by a short squeeze, given the high short interest, and, to a lesser degree, speculation by retail investors on forecasts for the new gaming cycle and the involvement of activist RC Ventures,” said Joseph Feldman, an analyst at Telsey Advisory Group, in a note on Monday.
“We believe the current share price and valuation levels are not sustainable, and we expect the shares to return to a more normal/fair valuation driven by the fundamentals.”
For now, GameStop enthusiasts haven’t shown signs of wavering. For the second trading day in a row, trading was halted due to high volatility, as investors drive the price up by double digits.
Hamza Shaban, The Washington Post