Feb 5, 2021 4 min read

The national news has been filled with stories about GameStop. Since the beginning of January, the stock price has exploded, with some reports saying it has been up 2,000%!

How does this happen, and is this a good investment for you?

Let’s look at the fundamentals. GameStop has been in existence since 1984, when it was founded as Babbage’s. It sells video games and consoles, and selling video games was one thing that made this retailer different.

A new game might sell for $60. You could buy that at GameStop, which might have a used copy of the same game for $30. It bought the used game off a consumer who either got tired of the game or didn’t enjoy playing it.

Often, the seller will purchase a new game while he or she is in the store. Many of GameStop’s brick-and-mortar stores are located in shopping malls.

The company was not performing very well, as its stock price went down for six straight years. It closed 321 stores in 2019, and total store closures for 2020 – not released yet – were expected to be higher. In 2020, the company lost $165.7 million and the stock was selling for about $6 dollars per share.

There are serious questions whether GameStop might go bankrupt. Streaming is becoming a bigger part of the gaming industry, and some of the newer games that come on disk cannot be reused as often as before. This makes reselling used games less profitable. And many malls are hurting.

This does not seem to be a company you would want to invest in for the long term.

With this terrible outlook, you would never think we’d see the returns that the stock produced in January. Hedge funds are very large corporate investors. They make some investments “long,” which means they – like most investors – believe the price will go up.

Unlike most investors, they also invest “short” which means, they believe prices of the stock will go down. The hedge funds believe, maybe rightly so, that GameStop is not a viable business.

When you short sell a company, you pay a fee and borrow stock from a broker. You expect to replace the borrowed shares when you buy them back at a lower price when the stock tanks. This is how you make a profit.

One social media platform saw the huge short positions in the stock and got many of its followers to buy. Most of the purchasers were day traders, not investors. As their money poured into the stock, the price rose quickly. All stocks rise when more people want to buy, and go down when more people want to sell.

This situation was compounded because all of the hedge funds were getting squeezed as the price went up. They had to buy shares because they must maintain certain margins in relation to the borrowed stock and try to lower their risk. This made the price go up faster. It is estimated that hedge funds have lost $20 billion on paper.

One irony about this stock run-up is the company is not any stronger today than it was last year. It does not receive these inflated stock prices because they go to the investors. This phenomenon will end when the hedge funds have covered their shorts. They will have no interest in owning a money losing stock at unrealistic values.

Whoever owns the shares at that time will have to take a huge loss because no one will be willing to buy at those inflated values. The stock probably will end up somewhere close to its value when this whole thing started. This is not the kind of speculation most investors should engage in, and certainly not risk their retirement savings.

Next week, we will discuss some other valuations in the stock market.

Gary Boatman is a Monessen-based certified financial planner and the author of “Your Financial Compass: Safe passage through the turbulent waters of taxes, income planning and market volatility.”

To submit columns on financial planning or investing, email Rick Shrum at rshrum@observer-reporter.com.