Meme stocks defy logic, fundamentals and especially Wall Street. Skeptics cringe in disbelief at every “to the moon” rally. While meme stocks are seemingly everywhere in the media, many investors may not be aware how they came to exist and what they actually are.
As long as there have been markets, there have been investment vehicles or sectors that have fascinated the public – due to increased information accessibility and/or technology platforms – and soared to incredible valuations. Meme stocks are just that next progression: they were created at the new crossroad where the democratization of information met the Uberization of stock trading.
There are few definitions or specific descriptions of meme stocks. They seem to have appeared out of thin air, not solely belonging to growth or value, small cap or large cap criteria. However, there are four basic characteristics of these stocks:
The lack of earnings produces negative expectations by investors, which leads to increased short positions. A narrative of expected growth or paradigm shift, exacerbated by ambiguous claims, creates a positive buzz and short-covering rally fueled by technologically enhanced cheerleading. And ta-da, a meme stock is born!
The democratization of information is the increased accessibility of information through improved technology to the masses. From the printing press, to the radio, to the television, to today’s internet, it is the transfer of knowledge from a privileged few to the greater portion of the general public.
The positives to this democratization are instant and constant information flows accessible to anyone with a computer or smartphone. This open access to news as it happens provides all investors with an equal playing field.
However, the new information platforms are not solely data providers. They also provide the public with a sounding board for opinions, emotions, inaccuracies and unreliable advice. As access to information expands, so too does the risk of misinformation for investors. Platforms – such as Reddit and Twitter– can help create and sustain a single-minded herd mentality that drives prices beyond reasonable valuations. Investors should be cautious of this speculative groupthink as it limits objective financial assessment. And herds are eventually led to slaughter.
The Uberization of something is the utilization of a technology platform to eliminate the traditional middleman, expand the reach and supply, and drive consumer costs lower. Obviously, Uber is a prime example of a smartphone platform that enabled anyone to become a taxi driver and revolutionized local transportation. Airbnb and VRBO accomplished similar transformations to the hospitality industry. And Robinhood has transfigured stock trading.
Zero-commission trading from a laptop or smartphone allows anyone to trade stocks. No longer are you required to maintain hefty balances at a brokerage and pay relatively high transaction fees. The middleman has been mightily reduced and practically anyone can invest. But, as with increased democratization, there is a downside to stock trading Uberization: lack of knowledge.
Prior barriers to entry – necessary funds, brokerage account, etc. – provided either increased time for an investor to acquire financial education, or a fiduciary agent with existing market experience.
This dearth of experience and knowledge permits investors to place their money into highly speculative vehicles without a true understanding of the risks. And it is risk that separates investing from other Uberized activities. An Uber or Airbnb cancellation fee is a miniscule utilization risk compared to “playing the market” with meme stocks.
Risk is a component in all investments. Risk is the chance for loss of some or all invested money. However, investing is different than speculation. All investments have a degree of speculation: the utilization of money over a time period to obtain a return.
However, speculation attempts to profit solely on short-term price dislocations, with little regard for fundamentals such as earnings, debt, cash flows or product. An investment requires more information and longer time horizons, which also helps minimize risk. Unfortunately, participating in meme stocks is purely speculative and thereby magnifies investor risk.
Taking the time to learn to invest, starting with mapping your financial goals, understanding your risk profile, and what makes a stock a quality investment are all things you should nail down prior to chasing a meme stock. Even if you are more on the risky side and love trading, take the time to learn to trade options can significantly reduce the potential of a major loss
Similar to cryptocurrencies (see our article “Can Cryptocurrencies Actually Become A Real Currency?”), meme stocks will be around for the foreseeable future. Technology advancements allow for low-cost trading access while also providing a platform for instant information access to the general public.
However, this enhanced connectivity also permits inaccurate commentary and emotionally biased opinions to potentially cloud investors’ objectivity and clarity, and thereby increasing risk. And while the government may try to impose restrictions of some kind, it cannot control the internet.
Some form of meme stock activity will continue. Yet, investors must be aware that eventually the actual financial fundamentals of a company – and not the herd – will decide the true value of a stock. Investors should fear that trading in meme stocks goes from $YOLO and $FOMO to $OH NO!