Meme stocks are a relatively new phenomenon. The term refers to equities that have skyrocketed in value without any fundamental justification but are instead seeing their stock prices turn quite volatile based mostly on hype, often from social media platforms.

Notably, AMC Entertainment Holdings (NYSE:AMC) is among the most popular meme stocks at the moment. Its share price has surged 2,500% this year, driven by irrational enthusiasm from retail investors looking to strike it rich. And some have certainly succeeded, becoming millionaires almost overnight. But many others are likely to get burned when the stock price finally returns to more normal levels.

If you own shares, here are three reasons to sell AMC stock right now.

1. Fundamentals always matter

Famed investor Benjamin Graham once said: "In the short run, the market is a voting machine; but in the long run, it is a weighing machine." In other words, popularity drives price action in the short term, but fundamentals matter more over time.

Movie theater marquee marked with one word: closed.

Image source: Getty Images

Anecdotally, I've read comments from a shocking number of AMC shareholders who assert that fundamentals (things like revenue, cash flow, and valuation) simply don't matter. When confronted with these metrics, they dismiss them and instead resort to accusations of short interest. And maybe some of the dissenters are short-sellers, but I have never been long or short AMC stock.

Here's the unfortunate truth: Fundamentals always matter. Maybe not today, maybe not tomorrow, but eventually the stock price will reflect that. And if AMC's financial picture doesn't improve, the stock price will eventually plunge. And management knows that.

In fact, in a recently filed Form 8-K, management issued this warning to shareholders: "Under the circumstances, we caution you against investing in our [stock], unless you are prepared to incur the risk of losing all or a substantial portion of your investment."

2. AMC stock is wildly overvalued

The pandemic hit AMC hard last year, forcing the company to shutter theaters around the world. Not surprisingly, that sparked sharp declines in attendance, sales, and profitability. And despite reopening many locations this year, those metrics are still in free fall.

Metric

Q2 2020

Q3 2020

Q4 2020

Q1 2021

YOY attendance growth (decline)

(100%)

(93%)

(91%)

(89%)

Revenue growth (decline)

(99%)

(91%)

(89%)

(84%)

Source: AMC SEC filings. YOY: Year-over-year.

Oddly, as sales have plummeted, the share price has hit new highs, driving the price-to-sales (P/S) ratio to nonsensical levels. If AMC was competing in a high-growth industry, its present valuation might not be alarming. But it competes in a slow-growing sector of the entertainment industry. Case in point: Box office revenue grew less than 1% per year between 2010 and 2019.

Metric

Q4 2014

Q4 2017

Q4 2020

Q1 2021

Price-to-sales ratio

0.95

0.38

0.20

24.22

Source: Ycharts. P/S multiples reflect data from the last day of each quarter.

I'll end with this observation: Competition from streaming services has never been greater, and AMC's financial performance has never been weaker, so why is AMC stock valued more highly than ever before? At its current price, this is a dangerous investment.

3. AMC has a liquidity problem

Before the pandemic, AMC had $265 million in cash and $4.7 billion in debt on its balance sheet. It also had $4.9 billion in operating lease liabilities (i.e., rent).

When the pandemic hit, the company deferred a portion of its rent, but still couldn't cover operating expenses and interest payments. So AMC issued more debt and new shares several times during 2020, effectively digging the hole deeper.

As of March 31, 2021, AMC's balance sheet was insolvent -- even if the company sold every last asset, it still wouldn't have enough cash to cover its liabilities.

Now, in order to meet its minimum liquidity requirements, attendance must reach 85% of pre-COVID levels by the fourth quarter of this year. If that doesn't happen, management said it would likely seek a "restructuring of [its] liabilities." That's a fancy phrase that means shareholders would be completely wiped out.

So let's ignore the red flags raised by AMC's valuation. Investors still need to ask this question: Can attendance reach 85% of pre-pandemic levels in that time frame? If you aren't certain the answer is yes, then it's time to sell this stock. There are better places to put your money.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.