The GameStop shares frenzy: 3 things investors need to know

There’s been plenty already written about the frenzy around GameStop shares, and for good reason. It’s an interesting and somewhat unusual situation. But rather than rehash all of that here, I’d rather cut out all of the noise and consider three things to learn from this situation that could actually […]

There’s been plenty already written about the frenzy around GameStop shares, and for good reason. It’s an interesting and somewhat unusual situation.

But rather than rehash all of that here, I’d rather cut out all of the noise and consider three things to learn from this situation that could actually help you.

1. Pigs get slaughtered

This is a cliché amongst investors, but it’s true. Get too greedy and it’s bound to end poorly.

In this case, if you were an investor early to the party, you may have made a phenomenal amount of money (on paper) by punting on GameStop’s shares. At the beginning of the year, shares were close to $17. On 27 January, they closed at nearly $350.

Here’s the problem: as I write this, shares are trading below $100. If you were a late arriver, greedily jumped in because it looked like everyone else was making easy money and paid more than $300 per share, you might be licking wounds right now.

Investing is about making money. But the surest way that I’ve found to make that work in your favour is to do it slowly, over time. Getting greedy and trying to make quick riches is often the way to learn hard lessons in the share market.

2. No, the share market isn’t always rational

You may hear talk of ‘rational markets’, or that the share market ‘prices things in’. The idea here is that with so many investors taking part in the share market, at any given time all information about a company is reflected in its shares.

The further claim is that shares are always at a ‘right’ price because of all of this information reflected in the market.

But riddle me this: how does it make sense that GameStop started the year at $17, swung up to more than $300 and is now below $100?

The answer? It doesn’t make sense. The market isn’t always rational. Sometimes that means that a company’s shares are underappreciated and the share price is too low. At other times, it means that there’s so much excitement about a company that its shares are priced far higher than what that company is really worth.

The bottom line is that you should respect the fact that there are a lot of diverse investors with a lot of diverse information participating in the share market – meaning that shares are often priced rationally.

But that’s not always the case, and when it’s not the case, there may be an opportunity for you (on under-valued shares) or serious risk (on over-valued shares).

3. The investing wave of the future? I think not.

Some might be tempted to think that massive online groups like Reddit’s wallstreetbets are the future of investing. After all, they are showing the power of online communities against multibillion-dollar hedge funds.

Don’t bet on this. It’s an interesting story, and they are indeed giving some hedge funds a run for their money (quite literally). But something that doesn’t change in the midst of all of this is the nature of shares.

Shares represent an ownership piece of a company. All of a company’s shares collectively represent the value of that company. The huge support from wallstreetbets traders doesn’t really change the value of GameStop*, but rather just temporarily pushes up the price of its shares.

Does that sound fishy? Try thinking about it this way: imagine two companies, Boring Plc and The EveryoneLovesMe Company. They both pay all of their company earnings in dividends, and so shareholders receive a £1 per share dividend annually.

At first, both have the same £20 share price, which makes that £1 dividend a 5{429fc2506e610357e12b2a5665db82631200a2e00b3a1d8839077d76f18e2e8b} dividend. But then, an online community goes crazy for The EveryoneLovesMe Company and pushes shares up to £200. Now new investors can either buy shares in Boring Plc, with its £20 share price and 5{429fc2506e610357e12b2a5665db82631200a2e00b3a1d8839077d76f18e2e8b} dividend, or they can buy The EveryoneLovesMe Company at £200 per share and a 0.5{429fc2506e610357e12b2a5665db82631200a2e00b3a1d8839077d76f18e2e8b} dividend.

Think about it: once the initial excitement over the share price spike for The EveryoneLovesMe Company has worn off, new investors are likely to be much more interested in the 5{429fc2506e610357e12b2a5665db82631200a2e00b3a1d8839077d76f18e2e8b} dividend than the 0.5{429fc2506e610357e12b2a5665db82631200a2e00b3a1d8839077d76f18e2e8b} dividend.

That’s a drastic simplification, of course, but it generally illustrates how, over time, even wild and crazy shares find their way back to more sensible prices.

*Unless the company sells new shares, which would hurt the traders hoping for the stock to keep flying high, but could put a pile of new cash in GameStop’s bank account. Though even in this case, it wouldn’t change the value of the company nearly as much as the recent share price action suggests!

What to do about GameStop shares now

This isn’t an article about whether to buy shares in GameStop now. But if you’re reading this, that question is very likely on your mind. With that in mind, I’ll close with a couple of points related to that question.

First, I’m not buying GameStop shares. You may or may not care about that, but as you’re reading my article, you can be assured that I have no position either way. That is, I neither own shares myself nor have I ‘shorted’ them. I’m staying firmly on the sidelines with a bowl of popcorn.

Second, let’s reiterate the points above:

  1. Getting greedy in the share market is often a recipe for losing a lot of money
  2. Despite what some academic papers may say, the share market isn’t always rational
  3. The Reddit and online communities banding together for trades like this does not alter the fundamental nature of investing.

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