This article was inspired by the question “What does Warren Buffett think about GameStop”. This is my effort to view recent events through the lens of Warren Buffet’s mind. I don’t know Buffett personally (although I’ve met and chatted with him a few times at social functions here and there), but I have been an avid follower of his investment philosophy for decades. I’m guessing that what follows is pretty close to the mark.
What’s going on with GameStop?
It’s January 27, 2021, and GameStop stock (NYSE:GME) is continuing to shoot up. Things are moving so fast that my only hesitation in writing this article is that it may end up being obsolete before I’m able to finish it. The essentials of the story are that GameStop is a company that is in trouble, it therefore attracted a lot of short interest, that short interest attracted a bunch of individual investors, and the market went insane.
Quick background on GameStop
If you’re one of the few people who has been in a shopping mall in the last few years, you might have seen a GameStop store.
What internet existed back then was still in it’s early stages. The idea of buying software on-line and downloading it directly was still in the future. Retail operations like Babbage’s existed so consumers could go to the mall and buy software in a box. Things like game console cartridges and floppy disks were high-tech stuff in those days.
Over the ensuing 37 years, through a series of mergers and acquisitions, Babbage’s evolved into GameStop, and for a period of time, did a good business selling to the video game market.
What happened to GameStop?
Starting around 2016, GameStop went into decline, and for fairly obvious reasons. It was a double-whammy: First, consumers moved from buying software in boxes at retail stores, and started downloading it off the internet. Second, consumers started buying more of everything online, and stopped going to shopping malls.
The stock market took notice. By August of 2020, GME stock was down around $4/share, compared to an all time high of over $60/share.
This was a stock (and a company) that was generally thought to be circling the drain. Their business model was obsolete. It was all over.
Enter the “Shorts”
With everyone convinced that a GameStop bankruptcy was inevitable, “short sellers” stepped in. I won’t go through all the mechanics of short selling here (this article does a good job of explaining it), other than to make three points:
- Short selling is what speculators do when they think a stock is going to go down.
- Short selling means you borrow stock from someone else (like a brokerage) and sell it in the belief that you will be able to buy the stock at a lower price in the future. It’s still “buy low / sell high”. The only difference is short sellers sell first and buy later.
- Short selling is very high risk: If the stock goes up instead instead of down, the losses short sellers face are unlimited.
Which is to say, when you buy a stock the normal way (the way Warren Buffett buys stock), the most you can ever lose is whatever you spent on the stock. If you short sell a stock, there is no limit on how much you can lose.
When you think about Warren Buffett and GameStop, the essential thing to keep in mind is that everyone is speculating, and Buffett doesn’t speculate. You will never hear Buffett talk about the benefits of short selling, or how much money he made on short selling, or anything remotely like that.
Reddit gets in on things
Reddit has a sub-forum called WallStreetBets where amateur/individual investors trade stock tips and ideas. In late 2020, some users there noticed that GameStop stock had a high degree of “short interest”, meaning they could see that there were lots of speculators shorting the stock.
In something of a “Madness of Crowds” sort of way, the Reddit users started buying GameStop stock. Not because they thought GME was a great stock to own (they weren’t making a Warren Buffett style investment in GameStop). They did this because they wanted to punish the short sellers.
When a short seller sees the price of a stock going up instead of down, he is in big trouble. He is losing money, and the only way to stop losing money is to buy the stock. As long as the stock is going up, the short seller is losing more and more money. That’s what short selling is: You sell borrowed stock. Eventually, you have to buy the stock to repay the person you borrowed it from.
The Reddit users, more than anything else, acted out their animus toward large Wall Street operators. They weren’t buying GameStop because they believed it to be a fundamentally sound company with good prospects. They were buying it exclusively because they knew doing so would put the hurt on the Wall Street short sellers.
Acceleration event #1
Chewy.com co-founder Ryan Cohen has a plan for a GameStop turnaround. Through his RC Ventures firm, he started accumulating stock last year. Then in January, 2021, Cohen and two associates were granted seats on GameStop’s board.
The plan is to re-structure GameStop away from their brick-and-mortar roots into an on-line, video game company.
I have no opinion on whether or not that is a good plan, or whether or not Cohen has a reasonable chance of success with it. But if anything is true in this story, it is that it doesn’t matter. All that matters is that that little sliver of good news was enough to propel GameStop from an already frothy $20/share on January 1 to over $40/share by January 18.
This is all market exuberance in action. Even if one fully buys in to Cohen’s plan, you would have to conclude that at the January 1 price of $20/share, the plan was already “priced in” and then some.
Acceleration event #2
Like the Reddit users, Elon Musk (the Tesla guy) is no fan of Wall Street short sellers. They have been beating up Tesla stock for years.
Musk used his notoriety (and over 43 million social media followers) to give GameStock some attention. On January 26, he put out a one word message:
(“Stonk” is Reddit slang for stock.)
That message was a match tossed onto a floor awash with gasoline! Suddenly, everyone was paying attention.
The smart money (the Warren Buffett money) looked a this and, at most, gave a chuckle. The dumb money (the Reddit guys) jumped in bought even more. As of this moment (11:30am EST, Jan 27, 2021) GME has traded over 47 million shares for the day, and is up over $200/share to about $350/share.
Who are the good guys and who are the bad guys?
By Warren Buffett standards, the GameStop story has no good guys or bad guys. Only fools.
The large hedge funds who are suffering heavy losses from their short positions are getting exactly what they deserve.
The Reddit users are going to find out quickly that they played themselves for fools as well. When you read the WallStreetBets page, you see that they keep telling each other “DON’T SELL! DON’T SELL”. Why would they do that? Because they know that as soon as any hint of selling starts, it will be a “gold rush” as everyone tries to lock in their enormous (on paper, anyway) gains. As soon as that happens, the price of GME will collapse, probably right back to somewhere around $5 to $15/share.
The reality is that, as Warren Buffett would tell you, GameStop isn’t worth any more today than it was last year. You will frequently hear him say something like “I’d rather buy a great company at a good price than a good company at a great price”. Well, at the moment, GameStop is not a good company, and it is not trading at a good price. It is a terrible company that might, maybe, have a new direction that is yet to play out, and that is selling at a ridiculously high price.
When the dust settles from all of this, a small number of the Reddit users will pocket large gains. Most of them, on the other hand, will lose most or all of the money they put into this. At the moment, they are drunk on power and acting irrationally. They think they’ve found a secret way to stick it to the big guys (and to be clear, some big guys have truly been stuck). That won’t hold.
What if I want in on this?
I’m just a simple business owner, running an honest business. I’m not a financial advisor. But my advice is to sit back and enjoy the show. Forget trying to jump into this mess. It is nothing but chaos, and the odds of anything good happening for you at this point are no better than the odds of something bad happening.
That said, if you must, I observe that as of this writing, you can purchase April 16 PUT option contracts on GME with a strike price of $40/share for about $13/share. If GME drops back down to $10/share or so before April 16, you’ll do a little better than double your money. If it doesn’t you’ll lose everything. Either way, I’d far rather purchase PUT options than sell a stock short. At least with PUTs, your risk is limited to what you spend on the contract.
And to be clear, I am not buying those PUT contracts for my personal account, and don’t think you should either. If the above paragraph sounds like Greek to you, then you really shouldn’t do this.
The broader lessons from Warren Buffett and GameStop
The basics of “buying a great company at a good price” have not changed.
But we shouldn’t ignore this, either. Today we have millions of individual investors armed with their RobinHood accounts who, it seems, bring an unexpected perspective to the market. We used to assume that people made market decisions based on their best judgement of how to make the most money. What if that isn’t true anymore?
I don’t think the Reddit users are motivated by profit. (If they are, they are fools, since most of them are destined to lose and lose big.) I think they are motivated by what you might call a sense of righteous justice.
I give them credit for knowing what they are doing. They see the GameStop story as something of a moral attack on the morally bankrupt. They see the short sellers and other Wall Street operators as preying on innocent people, and causing economic devastation in the process. The Reddit guys have seized on this moment to give Wall Street some payback, even if it costs them everything. The astonishing thing to me is that these are real people putting their own real money at risk. They have skin in the game.
Is this a social media mob?
One way to look at this is that the Reddit people are a social media mob. They do these things because they believe they are acting righteously. They are invested in the idea that society itself is corrupt and needs to be “deconstructed“.
Author and social commentator Camille Paglia put it well: “The evidence is all around us—the paroxysms of inchoate, infantile rage suffered by those who have turned fallible politicians into saviors and devils, godlike avatars of Good versus Evil.“
Is this episode an example of “inchoate, infantile rage”? It might be.
Or maybe they are doing this because they think it is funny. They aren’t wrong. I have to confess a certain amusement at watching the Wall Street hotshots getting burned.
In either case, the lesson I take from this is to be more “Warren Buffett” in my investing than ever. The presence of the Reddit mob, standing ready to impose wild swings on risky stocks at unpredictable times, leaves me all the more convinced that I want slow, steady and boring.
What to watch for
This kerfuffle will play itself out fairly soon. Probably within the next month or so. I’m fairly certain that Wall Street has been taught a lesson. I expect we will see a lowering of enthusiasm for short selling. That’s probably a good thing.
But what about the Reddit users? Most of them will be left with punishing losses. I’m interested in observing how they react.
Will they say to themselves “Well, that was dumb. We shouldn’t have done that. I think we all learned a lesson, right there”?
Or will they say to themselves “The ‘system’ figured out a way to screw over the little guy, once again”?
Or will they say “Yes, we took a beating, but we did a lot of good in the process, and it was worth it!”?
I don’t think we’ll have to wait long for the answer.