GameStop stock price is rational. Here’s why: #SP500orBust
Disclaimer: I’m not a financial professional and this is not financial advice. I currently hold GameStop stocks, but given the current market conditions I may decide to buy or sell some of the stock at any time.
All opinions expressed here are fully my own and do no represent any company or association I’m connected with. This article was written on 2021–01–31, and my opinions and stock positions may have changed since.
I’m not a financial professional by any means, I spend most of my time working with computer systems and programming. However, I take a lot of pride in my ability to learn and understand systems which have a well defined ruleset. The system can be anything from Chess and Go to electrical circuits to programming languages. As Randall Munroe of XKCD puts it,
If you take any financial ideas from this post, there’s a pretty good chance that you end up like the above engineer while someone else buys an yacht with your money.
What is the “right” value of a stock?
The old school approach would be to estimate all the future cashflows of a company and discount them to a present value. If a company is expected to make 1 USD / share / year and it is in a very stable condition, we might value the company with 10 % return rate which would make the stock worth 10 USD.
If the stock has higher risk, we discount it at a higher rate which lowers the valuation. If the stock has lower risk, we discount it at lower rate which increases the valuation.
It is very hard to make sense of the current stock market valuation with the above method of discounting future cashflows of companies to the present. However, the old school model doesn’t account at all for the greater fool theory.
What if someone is going to buy the stocks from me at higher price than I have paid for, regardless of how much I pay now?
Suddenly we can make a case for almost any valuation, as the risk has gone to zero. The future cashflow gets disconnected from the fundamentals of the company, and it becomes a function of how much current shareholders believe that there is going to be a buyer at a higher price. This is how valuation of cryptocurrencies and non-profitable tech companies suddenly start making sense.
Who is the greater fool?
Traditionally, this is the point where financial professionals will explain how we’re in another bubble and it will end up in the same way as all the previous bubbles: A glorious bust where common people lose their life savings and houses. However, I’m going to posit that this time the greater fool is the institutions. Why do I believe that?
There is a bubble. It’s not GameStop stock, it’s not the tech sector. It’s the passive index funds, who are the greatest fool of all.
Usually, if any investor would be broadcasting that they do not believe that the fundamentals of the stock they own justify the value of the stock, it would push all potential buyers off the market until valuation matches the fundamentals. However, passive index funds aren’t allowed to use reasoning in what stocks they buy. We have huge buyers who broadcast their buying conditions and they don’t care about the fundamentals.
The claim of index funds being a bubble isn’t new, and it is not my idea. Michael Burry told us back in 2019: https://www.bloomberg.com/news/articles/2019-09-04/michael-burry-explains-why-index-funds-are-like-subprime-cdos.
Making a case for SP500 inclusion of GameStop
My investment thesis for GameStop hinges on the points below, some of it backed by publicly available data and some by what rational actors working in their self-interest would do.
1 — GME is not a part of SP500 right now
2 — To be included in SP500, a company must fulfill these criteria
“To be eligible for S&P 500 index inclusion, a company should be a U.S. company, have a market capitalization of at least USD 9.8 billion, be highly liquid, have a public float of at least 10% of
its shares outstanding, and its most recent quarter’s earnings and the sum of its trailing four consecutive quarters’ earnings must be positive”
- U.S. company — https://en.wikipedia.org/wiki/GameStop, yes.
- Market capitalization of at least USD 9.8 billion — 10 B / 70 M shares outstanding mean that as long as shares trade over ~143 USD, yes.
- Highly liquid — Recently the trading has been so fierce that brokerages haven’t been able to keep up. Over the last year, some 5–10% of shares have been traded daily. Yes.
- Public float of at least 10% of its shares outstanding — https://finance.yahoo.com/quote/GME/key-statistics/ shares outstanding: 68.75 M, Shares float: 46.89 M. Yes.
- Its most recent quarter’s earnings and the sum of its trailing four consecutive quarters’ earnings must be positive — https://www.nasdaq.com/market-activity/stocks/gme/earnings No. Last 3 quarters totaled -3.54 USD. Next quarter was estimated to be profitable at 1.46 even before this frenzy started. Given the current frenzy around GameStop I consider it likely that the next quarter and ongoing quarter are going to total over 2.0 USD per share, and this criteria will be filled.
3 — This is not a prisoner’s dilemma where one defector spoils it all
A lot of people are going to argue that the current valuation is unsustainable because owners are going to cash out once the 10%+ daily gains are over. That is for sure, but it doesn’t change the investment thesis. The greater fool is going to be there, index funds aren’t going away. While old investors unwind their positions new investors are picking up the tab. Remember, valuation is based on the possibility of SP500 inclusion and influx of stupid money.
There’s only 46.89 M shares float, if 47 M people decide to own one share for the meme the index funds are going to pay ludicrous sums to get the one share off the owners. Robinhood had 13 M users last year: https://en.wikipedia.org/wiki/Robinhood_(company). They are not going to leave the market, even if they switch platform.
In a way, the recent buy limits of 1–5 shares might have been a blessing in a disguise. It has lowered the share price increase and lead to more equal distribution of shares. There will be less millionaires securing new sailboats by dumping shares on newcomers.
All that the people collectively need to do is to buy a few shares of GameStop and a PS5 + some games from GameStop.
4— There is nothing wrong in owning shares and using services
Some might even argue that the original purpose of the stock market is to give everyone possibility to benefit from being a part of a successful company. Nothing discussed here is illegal or unethical. There is simply a huge horde of common people who have had enough of being sidelined financially, sharing a rented apartment in their thirties and struggling to pay off their student loans while a small group of people have had the value of their assets skyrocket due to central bank policies of printing money and removing the risks of investments.
This is the moment where common people get access to central banking policy inflated asset prices. It’s not collusion, pumping, scheming, manipulating or anything like that. It’s only understanding the rules of market and acting on our own self-interest, based on publicly-available information.
This is not some grand revolution
It is an empowering picture: the little people come together, beat the Goliath and there is equality for all. In reality there is no The Man, System or deep state grand conspiracy. There’s only a lot of actors acting in their own self-interest, and this investment thesis relies on some big actors going through the same analysis and ending up in the same conclusion. We’re children in the playground, and the giants will battle this out without caring who they happen to step on. We’re only hitching the ride and probably end up taking the blame if this results in a systemic finance crisis.
Conclusion
All the talk about getting rich quick over gamma squeezes, short squeezes and sticking it to the man in a glorious endgame is short-sighted. The endgame is in the SP500 inclusion and guaranteed inflow of institutional money. The common folk will not be left holding bags this time if a large number of retail investors act together in their common self-interest and help GameStop to become a huge success as a company.
I hope you enjoyed reading my investment thesis on GameStop as much as I enjoyed writing it. I’m not claiming to be some kind of a guru who sees the future or knows how to makes easy, fast and risk-free money. You should not debate this with me, no matter if you agree or not. You should tweet #SP500orBust and let the marketplace of ideas decide if this thesis is correct.
