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Is it game over for GameStop’s share price and other “Reddit stocks”?

Is it finally game over for GameStop’s [GME] share price and the meme stock frenzy?

GameStop’s share price tanked 27% last Thursday (10 June) after it announced it had been contacted by the Securities and Exchange Commission (SEC) in May.  

In a probe first announced in February, the SEC will look over social media and forum sites for evidence of market manipulation. 

“We are in the process of reviewing the request and producing the requested documents and intend to cooperate fully with the SEC staff regarding this matter,” the company said in its quarterly filing with the SEC. “This inquiry is not expected to adversely impact us.”

The SEC's acting chair, Allison Herren Lee, said in February that the investigation will cover "compliance with regulatory obligations, adequate and consistent risk disclosure, and determining if any fraudulent or manipulative behavior has occurred." 

Adding further pressure to GameStop’s share price was the company’s filing with the SEC to issue an extra 5 million shares.  

“When you dilute for shareholders your stock price is supposed to go down, so in a way that is some sense of normalcy. Outside of that, GameStop trades on pixie dust and dreams,” Anthony Chukumba, managing director at Loop Capital, told the Financial Times.

"GameStop trades on pixie dust and dreams" - Anthony Chukumba, Loop Capital

 

Are AMC and GameStop’s share prices disconnected from fundamentals?

Since the announcement, GameStop’s share price has fallen 25% as of Tuesday’s close — illustrating that these sharp surges up, also come with a quick, sudden downside.

Chukumba notes that GameStop’s share price had become “completely out of touch with [the] fundamentals” of the underlying business. 

Looking at the stock, that fact is easy to see. For the current year, consensus on Yahoo Finance is that GameStop will make $5.48bn in sales, and $5.37bn the following year, a 2% decline. Yet, the video game retailer’s stock carries a monster $16bn market cap.

Another big meme stock, AMC’s [AMC] share price has also been caught up in the SEC probe. Having opened at $54.60 on 7 June, the stock hit an intraday high of $60.20 the next day, before plummeting to close at $40.58 on 10 June. 

Like GameStop, AMC carries an outsized market cap compared to expected revenues. In the cinema chain’s case, a valuation of circa $25bn is difficult to justify on forecasted revenues of $2.41bn this year, and $4.79bn next year.

 

Professionals and institutions pile into meme stocks

Chukumba suggests that the recent price swings are, in part, due to hedge funds also piling in to the sudden climbs higher, saying that “retail [traders] cannot create these sharp moves alone”. 

"Retail [traders] cannot create these sharp moves alone" - Anthony Chukumba, Loop Capital

While the SEC investigation won’t look into allegations of misconduct by hedge funds, it will look at whether professional investors orchestrated short squeezes to take advantage of the trading activity, or even helped to hype up stocks on the forums through fraudulent posts.

Even professionals and hedge funds have been burned by dabbling in the recent frenzy for stocks tipped on social media. Mudrick Capital has been one of the big winners on AMC, buying up debt to keep the cinema chain afloat then quickly flipping millions of dollars’ worth of stock for a profit, according to Bloomberg. To manage risk, the hedge fund also sold call options on AMC for more than $40, however when the stock surged past those levels counterparties cashed in, leaving Mudrick with a net 5.4% loss. 

 

Where next for GameStop’s share price?

An underlying concern is that meme stock trading skews the profile of financial markets like index tracking ETFs. The Russell 2000, which is nominally the home of small-cap value stocks, also contains GameStop. As you can see from their market caps, GameStop and AMC are far from value stocks, changing the risk profile of a product like the iShares Russell 2000 ETF [IWN]

The SEC probe may see the frenzy finally come to an end — or at least reduce some of the distortion the markets have seen recently. In May, the US securities regulator said it was looking at measures that would require large investors to disclose both any short positions and how they are using derivatives to bet on market movements. However, forums will continue to be a place where traders discuss trades, meaning that even with regulator intervention, they could still spark trends in the market.

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