Market Overview
Be a Tesla, not a GameStop
We were all set to write a column this month about how a stock like Tesla can go to the moon the way it has. TSLA, now trading in the mid-$800s, appears to be taking a pause after having climbed more than 200% in six months. We were going to discuss how a good stock has a good story, and how the company’s fundamental soundness and the brilliance of its management team can propel the value of its equity to majestic levels.
And then GameStop happened.
Short circuit
In case you missed it, GameStop (GME) surged 243% over the course of 2020. This stock, which traded below $3 some of the time, closed last year at around $20. And that would’ve been a nice success story for a downtrodden, well-past-its-prime, brick-and-mortar retailer.
After a rise like that, experienced investors took profits by selling their shares. More bold investors even shorted the stock. But GameStop is a sentimental favorite among the Millennial and Gen Z crowd. It’s a part of their childhood, and some young investors banded around a community in the Reddit social media platform to commiserate. They ended up hatching a scheme known as a short squeeze. If you really want a definition, Investopedia will oblige. Or you can ask your financial advisor, who will preface the explanation with a steely-eyed “Now don’t ever try this, but …”
Basically, these Redditors started buying up the stock, which had the effect of raising the price of GME. Because all these other investors – primarily hedge funds – had bet that the price would go down, their short positions became increasingly unprofitable. As the stock price soared, they had to buy more shares to cover their positions so they didn’t lose even more money. Throw in the fact that most of this was done on margin – that is, the fund managers borrowed money from their brokers to pay for the shares they borrowed from the same brokers.
And it all snowballed from there. GME ended up rising more than 1,700% in two weeks. Once the short positions unwound, though, the stock sank back down into the $50 range. So, even buy-and-hold investors may have made some money on this, as did some of the traders on Reddit. But the vast majority of investors who participated in all this speculation took a bath. Some hedge funds closed up shop.
Interestingly, all this damage was done for no economic reason. This was all about rooting for a sentimental favorite and, not insignificantly, “Sticking It To The Man”.
Tesla keeps rolling
Interestingly, the last stock before GME to get the short-squeeze treatment was none other than TSLA.
In early 2020, Tesla was the most-shorted stock on the U.S. exchanges, with “more than 18% of its outstanding stock in short positions,” according to Investopedia. “In late 2019 through early 2020, Tesla stock soared by 400%. Short sellers got hammered, collectively losing about $8 billion.”
That’s because there really is a strong investment case for Tesla.
“Tesla and its founder Elon Musk are at the forefront of a push towards a greener future, and the company’s position as an early adopter gives it a competitive advantage in the market,” according to CNBC’s Pippa Stevens. “Not only is Tesla a leader in electric vehicles, but its growing battery, solar and autonomous driving divisions will fuel future gains. Essentially, it’s a leader in its field, and the competition is well behind, say those who favor the stock.”
(So, if you’re looking for another reason why ESG investing is an important and timely topic …)
Strong demand for the Model Y and Cybertruck is only part of the story. So is the efficiency that comes with the auto division being 100% dedicated to electric vehicles. Also, its inclusion in the S&P 500 – which came about in December – means that funds not only want to own TSLA, now they have to. And while both production capacity and free cash flow continue to ramp up, there’s still more to come from Tesla, according to its proponents.
It’s a leader in creating new tech for autonomous vehicles. It’s got some of the best battery technology. And its betting on the continued rise of China and other emerging markets. So while TSLA is knocking on the door of $1,000 a share, you’ll hear a lot of chatter – not to be taken too seriously at the moment – of it going up to $6,000 or even $7,000.
Parting thoughts
Individual stock picking is tricky.
The fact that GME remained above its initial starting point is telling. It means that even a beat-down company like GameStop can be undervalued; there can be fundamental strengths or a change in strategy or some other overlooked company news that makes it a buying opportunity.
Similarly, a company with a good story and a lofty share price might just be overhyped. For every Tesla there’s a WeWork.
One trick, then, is to be able to distinguish what a stock’s true value is and what a realistic target price for it can be. Another is to determine whether that stock deserves to be a core, long-term holding in your portfolio, or is it just a flier that you’ve purchased for the value of its momentum.
As we’ve seen, though, it’s impossible to anticipate all externalities that might favor one company over its competitors. The typical investor makes more bad calls than good ones and, when you net those out, it’s hard to beat the overall market for any length of time. Maybe the best course of action is to invest in exchange-traded funds and then, every now and then, get in on a long shot. To guide you in determining your risk profile, it might be best to consult a financial professional.
