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The Grim Reality GameStop and AMC Investors Must Face

By Sean Williams - Feb 3, 2021 at 6:36AM

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This isn't about a short squeeze any longer.

The past year has been historic in a number of ways for the investing community. In no particular order:

  • The benchmark S&P 500 lost 34% of its value in just 33 calendar days, representing the fastest bear market decline of at least 30% in history.
  • The widely followed S&P 500 also took less than five months to recoup all of its losses and hit a new all-time high -- the quickest rebound from a bear market low on record.
  • West Texas Intermediate crude oil futures briefly turned negative in April.
  • The CBOE Volatility Index registered its highest reading since inception in March.

You'd think that with all that went on in 2020 we'd have purged wild equity swings from our system, but that's simply not been the case.

A visibly frustrated stock trader grasping his head while looking at losses on his computer monitor.

Image source: Getty Images.

GameStop and AMC captivate Wall Street's and retail investors' attention

Over the past three weeks, we've watched as predominantly downtrodden or forgotten stocks have rocketed into the stratosphere. Multi-channel video game and accessories retailer GameStop (GME -4.09%), which went for as little as $4 a share six month ago, and could be purchased for less than $20 a share on Jan. 12, finished last week at $325 a share and briefly hit $500 during Thursday's premarket trading session.

Another example of insane stock moves in action is movie theater chain AMC Entertainment (AMC -5.31%), which in a two-week span rose from the low $2's to as high as $20 on Jan. 27.

How on Earth are such gargantuan moves possible? The answer appears to lie with a group of high-spirited retail investors who want to show Wall Street what they're capable of. A large group of investors on Reddit's "wallstreetbets" chatroom have essentially banded together to aggressively buy shares and out-of-the-money call options on heavily short-sold stocks. A short-seller is someone who makes money when the share price of a stock falls (gains capped at 100%) and loses money when the share price rises (losses are unlimited).

What's made these moves so explosive is the potential to create a short squeeze. Since losses are unlimited for short-sellers, an explosive rise in a heavily short-sold stock can cause pessimists to rush for the exit. To get out of a short position, pessimists buy shares of stock to cover their position, which only exacerbates a strong upside move in a stock. This is one of the key reasons GameStop and AMC Entertainment catapulted higher, as they are among the most short-sold stocks relative to their float (i.e., shares available for trade).

Silver dice that say buy and sell being rolled across a digital screen containing stock chart and volume data.

Image source: Getty Images.

It's time for investors to face reality

But there's a key realization that investors in GameStop and AMC Entertainment need to come to terms with. Namely, this isn't about a short squeeze any longer. What we're witnessing now is nothing short of day-trading, pure speculation, and possibly even share price manipulation.

As of Jan. 15, Morningstar data showed that 61.78 million shares of GameStop were held by short-sellers. That made it the only publicly traded company with a short interest above 100%, and the perfect target for Reddit retail investors. Prior to the beginning of the Reddit raid activity, GameStop averaged fewer than 10 million shares traded daily. This meant it would have taken days for short-sellers to exit their positions, assuming they all ran for the exit simultaneously.

However, in the six trading sessions between Jan. 22 and Jan. 29, nearly 756 million shares of GameStop traded hands. That's more than enough liquidity for short-sellers to find the exit, and it's more than 16 times the company's float. What this tells us is that we're witnessing plenty of high-frequency trading and day-trading, and that we're well past the point of a short squeeze driving GameStop's stock higher. The fact that it has high short interest is now inconsequential.

The same goes for AMC Entertainment. AMC had 44.67 million shares held short, as of Jan. 15, which is relative to 114.94 million shares in its float. In the six trading sessions between Jan. 22 and Jan. 29, AMC saw nearly 3.58 billion (yes, with a 'b') shares trade hands. Again, that's more than ample liquidity for short-sellers to exit, and 31 times the company's float.

A one hundred dollar bill on fire atop a lit stove burner.

Image source: Getty Images.

But wait -- there's more

To pour additional cold water on the fire, this is a great time to remind investors that, while emotions drive short-term price movements, operating earnings growth is what drives long-term share price appreciation.

While GameStop did see its e-commerce revenue more than quadruple during the 2020 holiday season as the company continues to shift toward digital sales, the company's total revenue keeps sliding, and it's on track to deliver its third consecutive full-year loss. GameStop is attempting to backpedal its way into the profit column by closing physical stores in an effort to cut costs. I repeat, GameStop doesn't offer operating earnings, let alone growth.

As for AMC Entertainment, it narrowly avoided filing for bankruptcy less than two weeks ago. The company was able to raise $917 million through a combination of debt and equity financing, and is now considering additional share offerings in light of its stock sharply rising. AMC shouldn't be valued anywhere near $4.5 billion given the huge losses it's producing and its uncertain future. Even after the coronavirus has passed, it's not clear that consumers will have interest in seeing new films in the theater with streaming content growing more popular.

It's not a matter of if GameStop and AMC will come crashing back to Earth and crush a large swath of retail investors. It's simply a matter of when.

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Stocks Mentioned

GameStop Corp. Stock Quote
GameStop Corp.
$124.38 (-4.09%) $-5.31
AMC Entertainment Holdings, Inc. Stock Quote
AMC Entertainment Holdings, Inc.
$13.38 (-5.31%) $0.75

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