Reddit Trading and Short Squeezes
The share prices of several companies, including GameStop and AMC, recently appreciated rapidly to levels that are seemingly disconnected from the companies’ intrinsic value as estimated by most traditional stock valuation metrics. These price increases were driven largely by two factors: social media conversations and the “short squeeze” effect.
First, participants on online discussion platforms like Reddit started buying en masse the shares of heavily shorted companies, with the increased demand driving the prices sharply higher. Second, investors and investment firms that had shorted the shares of those companies, betting that the prices would go lower by buying shares and selling them to other investors, were required to either add more money as they lost massive amounts on their positions, or to buy back the shares to close out their short positions and stem their losses. As many of them did the latter, the resulting additional demand further drove up the share prices.
While this occurrence may appear to be a fundamental change in market dynamics, the fact remains that the intrinsic value of a financial asset equals the present value of all discounted future cash flows from the asset, and social media chats cannot change that fact. As we’re seeing now, the share prices of these companies are sharply reverting back down toward levels that are more in line with reasonable future cash flow projections, and investors would be well served to focus on actual value rather than fleeting price anomalies.
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- Anthony Winkels is Managing Partner and Wealth Advisor at Fortis Wealth Management
