Shares of video game retailer GameStop (GME +0.78%) were up over 1,600% in January alone. The stock had been the most heavily shorted on the market. Therefore, when a herd of retail investors started buying up shares, an epic short squeeze ensued.
Some long-term shareholders could be sitting on market-crushing gains. But other investors bought shares of GameStop just last week, perhaps hoping to ride the wave to higher profits. However, as of this writing, the stock is down roughly 50% from its biggest intraday high of $483 per share. And it's down roughly 30% from its highest closing price of $347.51 per share.
Therefore, those who bought GameStop stock last week are probably down big. If that applies to you or anyone you know, I believe there's only one thing that can save your investment now -- and unfortunately, you might not like it.
Image source: Getty Images.
Don't count on squeeze 2.0
To understand why you shouldn't expect a fresh iteration of the GameStop short squeeze, we should explore how these work in the first place. When shorting a stock, you borrow shares and then sell them. To cover your position, you buy shares, returning them to their owner. Your profit or loss is the difference in price.
In GameStop's case, retail investors bid the price up first, sticking short sellers with massive paper losses. Trying to avoid further damage, the shorts simultaneously ran for the exits, sending shares higher still. This is a short squeeze, and it can last as long as a significant number of shorts are covering their positions.
However, short sellers may have already mostly covered. According to a Bloomberg article citing data from IHS Markit, only 39% of GameStop's float is now sold short. For perspective, it was over 100% short interest just last month as the squeeze started. This makes sense since prominent hedge funds like Melvin Capital Management have already announced they've covered their positions at a substantial loss.
With each passing day, the possibility of a new high from a GameStop short squeeze becomes less likely.
One-year returns. GME data by YCharts
Your best hope now
In the short term, unpredictable things can happen with stocks, both positive and negative. Not all are material to a long-term thesis, but they can temporarily impact the price per share nonetheless. Therefore, accurately predicting a stock's price over weeks and months is little more than a coin flip.
Long term, GameStop stock could go up with strong business results. It's true that this is a struggling brick-and-mortar retailer. However, remember that Ryan Cohen, co-founder of pet e-commerce company Chewy, recently purchased a 12.9% stake in the company. Cohen believes GameStop is underperforming because it missed the digital revolution -- and as someone who's run a successful digital business before, he should know.
Cohen's plan for GameStop is simple. It includes getting rid of underperforming stores and expensive leases, optimizing its structure for e-commerce, and leaning in to digital and gaming experiences. By doing these things and more, Cohen believes the company can start gaining back market share. That's significant since he estimates the gaming market will be worth $200 billion by 2023.
Consider that GameStop stock had a dirt cheap valuation prior to the squeeze because the business was struggling. For much of 2020, the stock traded below 0.2 times trailing sales. Let's suppose that Cohen's plan works long term and GameStop starts regaining market share. Some of those sales could also have a higher profit margin thanks to its digital push. Therefore, it's not outrageous to think this stock could someday sustainably trade at a higher valuation. This and higher sales could push its market capitalization marginally higher than where it was last week.
The point is, if you're hoping to recoup your losses in GameStop stock, Cohen's plan is one of the best chances for it to happen. But this will be a multi-year transformation. In other words, you could be waiting a long time just to reach your original cost basis.
Image source: Getty Images.
Going forward
Cohen's plan isn't guaranteed to work. And those who bought GameStop stock last week might not be interested in waiting years just to get back to their cost basis.
Sadly, there's no proven road to short-term riches. But if you're sitting on big losses with GameStop, I implore you to not to throw the baby out with the bathwater. Sometimes we get caught up and invest in the wrong companies for the wrong reasons. That doesn't make investing a bad plan. In fact, there's plenty of top stocks that can help you build wealth if you're willing to patiently play the long game.
In other words, don't give up on investing if GameStop has got you down. Change your strategy to a proven method.
