Please ensure Javascript is enabled for purposes of website accessibility

3 Reasons to Avoid Meme Stocks

By Jeremy Bowman - Jun 22, 2021 at 8:03AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

They've changed the game, but that doesn't mean they're the right move for you.

The year isn't halfway over yet, but 2021 will go down as the year of the meme stock.

Previously ignored consumer stocks like GameStop (GME -6.39%) and AMC Entertainment Holdings (AMC -9.69%) have skyrocketed this year. Hordes of traders on social media platforms like Reddit are using techniques like short squeezes, viral memes, and hashtags to pump up the stocks and attract new investors. AMC shares are up 2,500% year to date, while GameStop stock has surged 4,000% over the last year.

Cryptocurrency Dogecoin (DOGE -3.38%) has also joined the meme party, racking up gains of as much as 12,000% this year, giving investors returns of more than 100 times for a brief period.

The meme stock boom, which has included a wide range of stocks at various moments, could signal a fundamental change in how the stock market works, but it could also be a massive bubble. Even as some investors have experienced eye-popping gains from the popular viral names, there are a number of reasons to avoid meme stocks. Here are three of them.

A man holding several $10 bills on a table with dice in it

Image source: Getty Images.

1. You'll never know when to sell

Deciding when to sell an ordinary stock is hard enough. It's nearly impossible to time the market, and assessing a stock based on other factors like valuation, growth prospects, and broader market conditions is tricky. But with meme stocks, it's essentially impossible to determine when to sell because the fundamental factors that apply to most other stocks don't apply here.

Similarly, a traditional buy-and-hold strategy seems unlikely to work with these stocks despite the "to the moon" cries from their fan base. That's because sudden parabolic gains can easily disappear, as we've already seen. In January, GameStop suddenly surged to $483 a share before plunging roughly 90% over the subsequent weeks. It's recouped some of those losses since then, but its trajectory shows how easy it can be with meme stocks to feel like you sold too soon or you held on for too long.

2. You could lose a lot of money

Most stocks trade at prices that represent a fair estimation of the business' underlying value. If a company is valued at, say, $10 billion, that price is based on the company's profits, growth prospects, assets, or some other component that has intrinsic value.

That's not the case with meme stocks, which trade more like lottery tickets. Their price could soar one day on an insignificant piece of news or a groundswell of support on social media, and crash the next as interest shifts and the news changes.

At this stage, with prices on these stocks already many multiples above their intrinsic values, buying meme stocks carries a risk of losing much of what you've invested. The recent volatility in the sector shows how quickly this can happen. If you bought GameStop at its peak on Jan. 28, you would have been down 90% in less than two weeks. Similarly, Dogecoin peaked at $0.74 ahead of Elon Musk's appearance on Saturday Night Live, but has fallen by more than 70% since then. Other meme stocks have also flown too close the sun. Koss, for instance, crashed as much as 85% in just a few days after its peak in January. 

While there's risk in owning any stock, most tickers won't lose half their value in just a few weeks, and the average one is much more stable than the typical meme stock.

3. They are simply overpriced

A stock isn't just a bet, it's ownership in a business, and the price of that stock generally represents the performance of that business over time. With meme stocks, that umbilical connection is severed, and valuations and prices skyrocket, divorced from the fundamental value of the company. The chart below shows the market caps of GameStop and AMC, the two most closely followed meme stocks. 

GME Market Cap Chart

GME market cap data by YCharts.

As you can see, the stocks' valuations are wildly higher than they've been at any point in the last 10 years before the meme stock boom, even though the fundamentals of both businesses have worsened during the pandemic. AMC saw attendance and revenue crash during the crisis, and faces a difficult path to recovery as most of its studio partners now have their own streaming services, allowing them to take new content directly to subscribers at home. GameStop, meanwhile, faces disruption from gaming systems going to all-digital platforms and broader pressure on brick-and-mortar stores. Other meme stocks like BlackBerry, Koss, and Express also look fundamentally weak.

Meme investors have favored consumer stocks with high short interest, and though that strategy has been effective to quickly pump up share prices, it now means that the prices of these stocks have little relationships of the values of the companies they represent.

That's one more reason to believe that any of these meme stocks could crash at any time without warning.

  

Jeremy Bowman has no position in any of the stocks mentioned. The Motley Fool recommends BlackBerry. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

AMC Entertainment Holdings, Inc. Stock Quote
AMC Entertainment Holdings, Inc.
AMC
$19.29 (-9.69%) $-2.07
GameStop Corp. Stock Quote
GameStop Corp.
GME
$37.93 (-6.39%) $-2.59
Dogecoin Stock Quote
Dogecoin
DOGE
$0.08 (-3.38%) $0.00

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
394%
 
S&P 500 Returns
127%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/18/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.