Value Investor Daily #24

The financial world was recently captivated by an extraordinary 179% surge in GameStop’s (NYSE: GME) stock price over just two days, reigniting interest in meme stocks. Four days later, the stock is down 64%.

GameStop has become emblematic of speculative mania, where market movements are driven more by social media buzz than by company fundamentals.

While the thrill of watching a stock skyrocket is undeniable, it starkly highlights the difference between investing and gambling.

For value investors, the lesson is clear: when market euphoria takes over, it’s best to step aside.

The Allure and Risks of High Beta Stocks

GameStop’s recent rally, which began on May 13, is a perfect example of high beta stock behavior.

High-beta stocks are those that are highly volatile and tend to move more than the overall market. While this can mean outsized gains during bull markets, it also translates to steep, painful losses when the market turns south.

For value investors, this kind of volatility is generally unappealing. We’re looking for a smoother ride.

Value investing, popularized by legends like Warren Buffett, focuses on finding undervalued companies with solid fundamentals. These investments typically have a low beta, meaning they are less volatile than the market.

When companies have substantial cash flows, their stocks are generally priced vs. those cash flows and tend to stay within a reasonable range relative to those earnings, lowering overall volatility.

Companies without earnings, low float, and high short interest can trade based on future potential, hot trends, or social media memes.

The rationale is straightforward: By investing in stable and undervalued companies, investors can achieve more consistent returns with lower risk.

GameStop: A Speculative Roller Coaster

On Monday, GameStop's stock saw a renewed speculative surge triggered by "Roaring Kitty's" social media post after a three-year absence.

He shared an image on X of a gamer leaning forward in his chair—a meme indicating intense focus.

This single post reignited retail investor enthusiasm, reminiscent of the frenzied trading that previously drove the stock to unprecedented heights.

Three years ago, Roaring Kitty, known on Reddit as DeepF%*$ingValue, was instrumental in the historic trading frenzy.

His posts ignited a movement where retail traders on WallStreetBets rallied against institutional investors shorting GameStop.

In January 2021, this collective effort propelled GameStop’s price from around $20 at the beginning of 2021 to an intraday high of $483 on January 28, resulting in billions of dollars in losses for hedge funds betting against the stock.

This frenzy disrupted Wall Street, challenged hedge funds, and prompted a reevaluation of trading regulations.

The 2021 meme-stock craze had a significant impact on the US stock market—but ended poorly. By 2022, the bear market wiped out the gains made by the YOLO crowd, according to data from JPMorgan Chase & Co.

This past week, GameStop surged 179% in just two days, only to plummet more than 64% by Friday’s close after disappointing preliminary first-quarter results. This surge cost short-sellers over $2 billion in just two days, according to S3 Partners.

This wasn’t the first time animal spirits have run wild recently, and it won’t be the last. When it happens again, grab some popcorn, watch the show, and just say no.

Investing vs. Gambling

GameStop's recent roller coaster ride exemplifies the difference between investing and gambling. Investing involves thorough research, fundamental analysis, and a long-term perspective.

Gambling, however, relies on short-term price movements and luck rather than skill or knowledge.

Speculation isn't inherently wrong, but it must be recognized as such. While it can offer high rewards, it also carries significant risks.

For those aiming to build wealth steadily and sustainably, follow the value investors’ creed—don’t try to make money. Instead, focus on not losing money.

Think about the risk more than the reward. If you get the risk evaluation right, the upside will take care of itself.

The Case for Value Investing

The contrasting approaches of Cathie Wood and Warren Buffett highlight the essence of value investing.

Wood’s ARK Innovation ETF, which targets high-growth, disruptive technology stocks, delivered impressive returns, especially during the pandemic, attracting massive investor interest. However, this approach also came with high volatility.

In contrast, Buffett’s Berkshire Hathaway focuses on diversification into durable moat companies, offering steady and stable growth.

Over the past five years, Berkshire Hathaway shareholders have experienced more consistent, higher returns, with less drama, than the volatile performance of the ARK Innovation ETF.

Value investing's appeal lies in its low beta benefits. Low beta stocks don’t swing as wildly with market fluctuations, providing a smoother ride for investors.

It’s a mean-reversion strategy that capitalizes on market inefficiencies by identifying stocks that are undervalued relative to their intrinsic worth and waiting for Mr. Market to come to his senses.

Indexing is also a viable strategy, but value investing seeks to match or exceed these returns with less volatility.

The book "High Returns from Low Risk: A Remarkable Stock Market Paradox" demonstrates that avoiding high-beta stocks leads to more successful and satisfying investing.

The authors present compelling evidence that low-risk, low-beta stocks frequently outperform their high-risk counterparts over the long term.

Here’s how the US Minimum Volatility ETF (USMV) has performed in the last 10 years compared to the S&P 500. It’s had the same results but with a smoother ride.

Conclusion

The latest GameStop saga is a compelling narrative of speculative fervor, but it also serves as a cautionary tale.

While the temptation to chase quick gains is strong, the principles of value investing advocate for a disciplined approach focused on low volatility and steady returns.

For those who want to engage in the excitement of high beta stocks, it’s crucial to acknowledge that they are speculating, not investing.

When markets go crazy—stay focused on balance sheets and cash flows and leave the memes to the algos and speculators.