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What Is a Meme Stock and How Does a Stock Become One?

October 19, 2022
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min

Meme stocks are a new phenomenon that emerged during the COVID lockdowns in which retail investors buy and sell shares of beaten-down companies. Find out more here.

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As millions of workers stayed home during the early phases of the coronavirus pandemic in 2020, they ordered home grocery deliveries, played endless video games, and watched the market crash—and then rebound with seemingly unstoppable momentum. To get in on the action, millions of investors started using commission-free trading apps, which make buying and selling stocks a breeze.

What no one saw coming was how retail trading activity would intersect with social media, leading some investors to focus on the stocks that were left behind by the bull market. Forget the winning FAANG (Facebook, Amazon, Apple, Netflix and Google) stocks; these investors touted the merits of market laggards on platforms like Reddit and TikTok, sending prices of some soaring. Thus was born the “meme stock.”

What is a meme stock?

Meme stocks are shares of companies that are in financial decline or even in distress that suddenly take off, driven by hype and unfounded enthusiasm on social media sites that are followed by large numbers of inexperienced retail investors. The phenomenon coincided with the pandemic lockdowns and work-from-home mandate, and was fueled by new investing apps that made buying and selling as easy as a single click.

How do stocks become meme stocks? 

Most meme stocks start as small, beaten-down companies that have some name-brand recognition, but are struggling because of an outmoded business plan or adverse market conditions. Often, professional investors at hedge funds are betting against the stocks, short selling the shares in an effort to profit from declining prices.

Typically, the meme stock cycle begins when a retail investor blogs favorably about the company’s prospects while downplaying the reasons the stock has declined. The blogger’s post, typically on Reddit or other social media venues such as Twitter or Instagram, causes the shares to rise. Other investors join the online chatter, encouraging other investors to buy.

As the herd stampede gains speed and the share price rises, short sellers, who borrow shares from brokers and sell the stock in the hopes they can pay it back when its price drops, are forced to buy stock at inflated prices to close out their positions to avoid mounting losses. This causes the share price to rise even more in what’s known as a “short squeeze.”

At some point, a few investors decide to  sell. They are the lucky ones. Eventually, the upward momentum collapses as the market runs out of new buyers willing to pay still more. Once the share price stalls, selling press mounts as investors race for the exits, leaving those who got in late as well as the short sellers with losses. 

GameStop and the dawn of the meme stock era

The meme stock era began in July 2020, as U.S. stocks were rebounding from the pandemic bear market earlier that year. A YouTube video post laid out a dubious investment thesis—that shares of a money-losing bricks-and-mortar video game retailer called GameStop, trading then at about $4, were a buy.

It seemed preposterous. GameStop sold the kind of goods consumers, like web-savvy gamers, mainly buy online. Sales were declining. The company was losing millions. And management was in turmoil. Yet the author of the post—known as Roaring Kitty—argued that shares were trading at a 35% discount to what they were worth and that competition from online retailers such as Amazon was exaggerated.

Roaring Kitty, who also posted on a Reddit community called r/wallstreetbets and other forums, said that the sheer volume of bets by hedge funds against GameStop—it was one of the most heavily shorted stocks at the time—could eventually help push prices higher.

By the end of September the stock had more than doubled to $10. 

At this stage a Canadian entrepreneur named Ryan Cohen, who founded and later sold the internet pet supply retailer Chewy, disclosed a 10% stake in Gamestop. The price rose more.

Soon after, news surfaced that a large hedge fund, Melvin Capital Management, held a large short position in Gamestop. That gave impetus to Roaring Kitty’s premise that a short squeeze was in the offing. By December the shares hit $19. 

The new year brought more profits for GameStop bulls—and pain for short sellers.

On Jan. 11, GameStop said that Cohen was joining its board with two former associates of Chewy. (He would be named chairman in June). GameStop took off, rising from less than $20 to a stunning, intraday high of $380 on Jan. 27, the day after Tesla Chief Executive Officer Elon Musk seemed to plug the shares on Twitter with the single word “Gamestonk!!” 

GameStop stock soon after collapsed, plummeting to $40.68 on Feb. 18. That turned out to be the low for the year, however, as Cohen embarked on a management overhaul and restructuring. 

Shares retraced their way up to $300, then dropped to less than $160 by the end of 2021. In 2022, the shares have see-sawed between $180 and around the equivalent of $100 (the shares split 4-for-1 in July 2022) as of late September 2022. The company continues to lose hundreds of millions of dollars and senior management has turned over. Normally, shares of a company in this kind of financial trouble would only go in one direction—down.

The hedge fund Melvin Capital lost nearly $7 billion, more than half its capital, by short selling GameStop and other meme stocks. Ultimately, it needed to be propped up with capital infusions from asset managers Citadel and Point72 Asset Management.

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Other meme stocks

Other meme stocks include:

Bed Bath & Beyond

Ryan Cohen’s acquisition fund, RC Ventures, has played a role in other meme stocks, including Bed Bath & Beyond, a home furnishings retailer that once dominated its market with low prices and ground-breaking inventory management and logistics. It hit a high of nearly $80 in December 2013. 

However, like GameStop, it began losing business to Amazon.com, suffered during the coronavirus shut downs, and was also one of the market’s most heavily shorted stocks. It hit a low of $4.41 in April 2020. The stock picked up from there, the next year hitting $52.89 on Jan. 27, largely because it was being touted by the same social media pundits who were pushing GameStop. The shares bounced up and down during the rest of 2021, but the general direction was lower. In March 2022, RC Ventures disclosed in a government filing that it held a 11.8%  stake in the company and wanted it to spin off a subsidiary. The shares ran up to a 2022 high of $22, but then began sliding again.

In August, Bed Bath & Beyond announced a financial restructuring and dilutive share offering. RC sold its position. As of late September 2022, the stock traded at about $6.

AMC Entertainment Holdings

The world’s largest movie theater chain is another example of how the Reddit crowd was able to breathe life into a company that was waylaid by the Covid lockdowns. The company was forced to shutter its theaters at the outbreak of the pandemic, prompting its shares to fall more than 70% from their 2020 highs, bottoming out at $2.01 in January 2021.

Then the company’s shares rebounded later that month as online forums linked its shares to those of GameStop, which was soaring on news of Ryan Cohen’s investment. AMC Chief Executive Officer Adam Aron decided to engage the social media crowd. In early May 2021, with the stock under $10, he began using Twitter to heavily publicize the reopening of the chain’s venues and to tout blockbuster movies coming to AMC theaters. The shares rose more than six-fold to $62.55. 

But reality intruded and as the strength of demand for home-streaming services became clear, the shares began a long retreat, and as of late September 2022 they traded at about $7.

BlackBerry

There was a time in the early 2000s when BlackBerry’s smartphones with tiny analog keyboards commanded a cult-like following. But Apple’s iPhones put an end to BlackBerry’s popularity and now the Canadian company is almost entirely focused on software for cybersecurity and smart automotive applications. (You can still buy BlackBerry phones but they haven’t been updated in years). 

As the company’s business dwindled, BlackBerry stock fell, trading for a little more than $3 when the pandemic lockdowns began. But then the social media hype took off and the stock spiked to $25.10 on Jan. 27, 2021, before retreating. The shares traded for about $5 as of late September 2022.  

Nokia

Another hot telecommunications stock from the early 2000s was Finland-based Nokia, whose handsets were both cutting edge and ubiquitous before the iPhone’s ascendance. As is the case with BlackBerry, the company has transitioned to related businesses, supplying hardware and software to communications-services providers such as telecom, cable and satellite companies. 

At the start of the pandemic, Nokia’s American depositary receipts (ADRs) fell 47% to $2.42, but rebounded to their previous levels within three months, again amid social media chatter. The ADRs briefly hit $9.79 on Jan. 27, pacing gains of other meme stocks, before the inevitable retreat. The shares traded for about $4.30 and of late September 2022. 

The bottom line

Meme stocks are a new phenomenon that emerged during the COVID lockdowns in which retail investors behave in herd-like fashion as they buy and sell shares of beaten down companies. Much of the enthusiasm is driven by posts on social media. Because these swarms of investors can, for a time, overwhelm market fundamentals, they can push valuations to extremes. Along the way, they are likely to generate profits for a few, losses for many, and existential risks for short-selling hedge funds.

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