If IPOs are risky investments, their cousins, meme stocks, enhance those risks without proportionally raising potential rewards. Like an IPO, a meme stock is fueled by excitement and speculation. But whereas excitement around an IPO comes from the reputation and profitability of the company making the offering, a meme stock’s popularity is largely divorced from the company’s fundamentals and inspired by a scheme to manipulate stock exchange rules to make a quick profit, or by the whims of internet pranksters.
While an IPO may or may not appreciate in value over time based on the company’s performance, a meme stock is much more likely to quickly deflate, as the memesters have decided arbitrarily to inflate the stock price at a chosen moment. [Editor’s Note: for the author’s column on what investors need to know about IPOS, click here.]
According to OpenMarkets, an Aussie fintech analytics firm, millennials and Gen Z are the dominant investors of most meme stocks. This is a direct correlation to their familiarity and use of social media. Since Gen X and baby boomers tend to be less speculative with their investment strategies, they rarely chase meme stocks. When boomers and Gen X do buy meme stocks, it is usually a stock prior to being labeled a meme stock. If and when a boomer does buy a meme stock, it is more about being relatable to them and less about being an investment, like buying a 1969 Mustang that they learned to drive on.
What Happened to GameStop?
Take the most famous meme stock, the GameStop short squeeze of January 2021. Redditors from r/wallstreetbets (a subchannel on Reddit where millions of amateur investors discuss high-risk investing) waited for an expected short of the stock for video game retailer GameStop (NYSE: GME), then used brokerage apps like Robinhood to buy large quantities of shorted stock with their COVID relief checks. This unexpected surge of investors raised the stock’s pre-market price to nearly $500 per share. Short sellers suffered heavy losses while existing GameStop investors and r/wallstreetbets newcomers who got in early and sold at a high price made a considerable profit.
Since then, though GameStop has experienced another brief spike and not quite fallen back to its original low price, its overall value has dropped by nearly 85% and neither market conditions nor corporate governance imply the company will have a resurgence. The stock short was meant to leverage a planned short and cause headaches for professional investors while making a profit for those in the subreddit who were in on the joke, not as a serious long-term investment.
What Makes a Meme Stock?
Meme stocks are easy to spot due to their sudden rallies, volatile price swings, and unusually high trading volumes as participants crowd online to drive up the price. For a prudent investor, terms like “sudden,” “volatile,” and “unusually” should be an excellent indicator of what sort of experience to expect with a meme stock.
There is always that chance to make big money on a burst of investment, but the risk of a major loss if one fails to get out on a high is significant. This is why meme stocks are so popular among an online crowd more interested in experimenting and interfering with the stock market. They may do this out of protest, opportunism, or just for a laugh, but their interest is not an indication of a rock-solid opportunity.
A meme stock can be from a company with strong fundamentals. Palantir (PLTR) and Nokia (NOK) both have serious potential upsides, for example. But those upsides are independent of their memetic status and not relevant to the success or failure of a meme surge.
When memesters crowd a stock to inflate the price, their goal is not to create long-term prosperity for the company but to inflate the price so some lucky members can sell high and make a significant profit. The price will then drop back to the company’s expected value, and may well drop below that given the erratic and destabilizing nature of this kind of attention.
Thrill-seeking individuals might enjoy speculating some of their investment portfolio on meme stocks. But doing so means embedding oneself in the online communities that determine the next such stock, as outsider investors rarely learn of an upcoming surge in time to buy low and sell high. Whether you are a millennial or a baby boomer investor, it would be wise to tread carefully before buying any meme stocks. The risks of losing big are great, only a few people per meme stock do better on the deal than one would investing in a surging IPO.
Unless an investor is flush with funds and enjoys the high risks and social experience of meme stocks, they are better advised to go elsewhere for investments that are more likely to provide reliable return over time.
Christopher Crawford is head of Sales and Marketing at Buffalo Funds. With over 10 years of experience working with financial advisors and family offices, Christopher notes that success for advisors begins with being a good communicator and a better listener. Buffalo Funds is an asset manager with 10 actively-managed no-load mutual funds.