By SJS Senior Advisor Andrew Schaetzke, CFP®.
If you invested in GameStop Corporation (Ticker: GME) five years ago, your holding’s growth would probably look something like the below.
Source: Google Finance, as of 29-Jan-2021.
What usually causes such growth? It could be that the company’s revenue has dramatically increased in recent years, and thus people want to invest now in the hopes of significant profits in the future. It may be that the company has become significantly more profitable, either via growing revenue, shrinking costs, or both. It could also be that the company was significantly undervalued in the past, and now the stock price is finally realizing the company’s intrinsic value.
In the case of GameStop, we don’t think that any of these explanations fit. From fiscal years (FY) 2015-2019, GameStop’s net revenue has decreased by roughly 28%.[1] GameStop went from a $379.2 million net profit from continuing operations in FY 2015 to $(464.4) million in net losses from continuing operations in FY 2019.[1] Additionally, GameStop has less total assets, as well as similar liabilities, in FY 2019 relative to FY 2015.[1] Preliminary financial data from GameStop suggests these trends are continuing for FY 2020.[2]
Source: GameStop 2019 Annual Report, Page 22.
If growing revenue, growing profits, or undervaluation cannot adequately explain GameStop’s dramatic valuation growth, what else can explain it?
We think the explanation is short-term price speculation. Price speculation is not new: it has happened many times in the past, and it has many names. For example, in 1936, John Maynard Keynes defined The Castle-In-The-Air Theory.[3] In the book A Random Walk Down Wall Street, Burton Malkiel explains The Castle-In-The-Air Theory as follows:[4]
This price speculation strategy has worked for GameStop stock over the past few years.[5] Famous investors such as Michael Burry (of “The Big Short“ fame) made significant investments into GameStop, while smaller individual investors have collaborated via Reddit and Robinhood to drive up the price.[6] Contrarily, some investors have decided to short the stock (profiting when the stock declines), and have declared their actions quite publicly.[7] Particularly for smaller stocks, in our anecdotal experience, when strong vocal investors publicly argue with strong vocal short sellers, short-term stock price volatility often follows. So far, this volatility has benefitted GameStop investors.
This recent GameStop situation shows the upside of price speculation. However, we do not believe that price speculation works for the vast majority of investors over the long-term. For example, as of 31-Dec-2019, DALBAR found that the average equity mutual fund investor underperformed the S&P 500 (a benchmark for the US stock market) by nearly 5% annually over a 30-year span.[8] For a $100,000 initial investment, that’s a 30-year ending portfolio balance of $437,161 for the average equity mutual fund investor compared to $1,726,004 for the S&P 500.[8] DALBAR argues that price speculation partially contributes to the average investor equity fund investor underperformance relative to the S&P 500.[9]
Other studies have also found significant underperformance for the average investor who invests in individual stocks as well as who engages in short-term price speculation.[10][11] If most investors underperform broad market indices by so much, why do these investors continue to price speculate? We think it’s a combination of psychology - such as not wanting to miss out on big opportunities, wanting to follow others, and not wanting to regret decisions (further defined below) - combined with significant investment costs such as transaction fees (including bid-ask spreads), expense ratios, and unnecessary taxes.
We think that investing well over the long-term is tough, but we think price speculating over the long-term is even harder. As hard as it is to watch stocks such as GameStop go up, we think the evidence is clear: investing in low-cost, tax-efficient, broadly-diversified mutual funds and ETFS will help our clients outperform the vast majority of investors over the long-term.
Important Disclosure Information and Sources:
[1] “GameStop Corp. - 2019 Annual Report“. GameStop, 2020, news.gamestop.com.
[2] “GameStop Corp. - Form 10Q”. GameStop, December 2020, news.gamestop.com.
[3] “The General Theory of Employment, Interest, and Money“. John Maynard Keynes, 1936.
[4] “A Random Walk Down Wall Street: The Time-tested Strategy for Successful Investing”. Burton Malkiel, 2016, W. W. Norton & Company.
[5] “GameStop Shares Fall as Some Brokers Curb Trades.“ The Wall Street Journal, 28-Jan-2021, wsj.com.
[6] “'Big Short' investor Michael Burry made a 1,500% gain on GameStop during its Reddit-fueled rally“. Theron Mohamed, 26-Jan-2021, businessinsider.com.
[7] “The GameStop Short Squeeze Shows an Ugly Side of the Investing World“. Gregory Zuckerman and Geoffrey Rogow, 28-Jan-2021, wsj.com.
[8] “2020 QAIB Report”. DALBAR, 2020, wealthwatchadvisors.com.
[9] “2019 QAIB Study“. DALBAR, 2019, cswadvisors.org.
[10] “Unconventional Success: A Fundamental Approach to Personal Investment“. David Swensen, 2005, Free Press.
[11] “Money: Master The Game“. Tony Robbins, 2016, Simon & Schuster.
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