What happened
Shares of GameStop (GME -0.37%) are plunging on Tuesday, furthering a brutal decline in the struggling video game retailer's stock price that began earlier this week. As of 12:35 p.m. EST, GameStop's shares had lost roughly 50% of their value.
So what
GameStop shareholders are learning painful but valuable lessons. The first is that buying into overhyped stocks in hopes that they will soar "to the moon" is a misguided and dangerous game. The second is that short squeezes don't last forever.
After soaring earlier this year, GameStop's stock has declined sharply over the past two days. Image source: Getty Images.
To be sure, trading restrictions imposed by Robinhood and other brokerages that limited investors' ability to buy GameStop's shares have no doubt contributed to the plunge in its share price. They may have even initiated the decline and helped to end the WallStreetBets-driven short squeeze that had helped to propel GameStop's stock price in recent weeks.
GameStop's supporters and free-market proponents have accused Robinhood of market manipulation. Robinhood CEO Vlad Tenev, meanwhile, has said that clearinghouse deposit requirements were the reason the company needed to impose trading restrictions.
Whatever the reason, Robinhood's actions likely only served to accelerate an eventual decline in GameStop's share price. Buying into the mania surrounding GameStop and other overhyped stocks in hopes that their prices would continue to rise to even more astronomical levels was never going to end well for most investors.
Traders who bought and sold shares early in the rally profited. But a lot of individual investors who bought later in the rally didn't sell in time and are now suffering the consequences.
Now what
Stock prices can be distorted in the short term for any number of reasons. But they eventually move toward a level that reflects the fundamental value of the underlying business. GameStop -- a struggling video gaming retailer whose stores are being displaced by digital game downloads -- was not worth anywhere close to $33 billion, which was the valuation implied by its stock price when it hit a high of $483 on Jan. 28.
It was only a matter of time before the market corrected this mistake.
Unfortunately, even after today's declines, GameStop's stock is likely still well above the true value of its retail business. Analysts at Bank of America believe GameStop's share price -- which is currently trading near $115 -- could plunge as low as $10. If they're correct, GameStop's shareholders could potentially lose more than 90% of their investment.
