What is a Meme Stock?

Hard to define, but investors should know it when they see it.

22 June, 2021 | 8:00
Facebook Twitter LinkedIn

Guy with sunglasses at a slot machine

A meme stock is a pure child of the 2020s. There’s no clear definition. It isn’t a value stock or a growth stock. It just… is.

Jokes apart, meme stocks are stocks that see dramatic price increases, mostly fuelled by people on social media (primarily Reddit, Twitter and Tik Tok). These stocks rarely have company fundamentals that back the rise in price, and are often highly volatile. So why do people buy them?

FOMO is one of the main drivers of investor buying. The term FOMO is an acronym that stands for the ‘fear of missing out’, originally coined by Patrick J. McGinnis in 2004 and used largely by the highly connected millennial and Gen Y generations.

“This ‘fear’ is spurred on by the fact that many of us are inundated with updates about our social circle’s activities, to the point that some individuals feel like they are ‘missing’ out if they are not actively participating in conversations or activities around them. The term is generally regarded with a negative connotation, sometimes contributing to a person’s indecisiveness or overcommitting to obligations,” Morningstar Canada’s director of investment research Ian Tam explains.

The first prominent example of a meme stock in 2021 was struggling video game retailer GameStop (GME). The stock traded $19 per share at the start of the year, but by January 28, it hit an all-time high of $483 per share.

 

What is a Meme?

A meme (pronounced MEEM, though some say Me-Me) is a part of the language of the internet. It is a way for social media users to quickly communicate an idea, style, trend, or behaviour. Initially, memes were a combination of an image and a catchphrase. Here’s one example:

Image of 'One does not simply define a meme' meme

 

 

The original image is from the movie The Lord of the Rings: The Fellowship of the Ring. In this scene, the protagonist Frodo Baggins has reached the home of the elf Lord Elrond with the One Ring. Elrond calls a council to decide what is to be done with the ring, which can only be destroyed by the fires of Mount Doom, where it was forged. The obvious solution is to take it to Mount Doom, and throw it in. At this point, Boromir, the prince of Gondor, (and up to this point, not a very likeable character) says, "One does not simply walk into Mordor". "Its black gates are guarded by more than just orcs. There is evil there that does not sleep. The great eye is ever watchful.”

Now remember, most people sharing the meme, especially in its initial days, know this. They know that the language is odd, and they also know that Boromir is unlikeable and pompous. Which is why – laughing at him is funny, and that is partly why the meme took off.

This particular meme always starts with the words, “One does not simply…” at the top, and usually something humorous at the end, implying that whatever the person is trying to do is complex, or un-doable. For example, if you’re trying to get tickets to the hit musical Hamilton, a friend might send you a picture of Boromir with the words, “One does not simply get tickets to Hamilton.” Though this is how memes begin, the concept is much broader and includes gifsvideoschallenges, and now, stocks

 

Should You Buy the Meme Right Now?

“No, investors should not buy into the meme mania – it should be contained within the realm of day-traders who are willing to speculate on momentum. Part of the reason Meme stocks such as these have arisen in the first place is FOMO, or fear of missing out, which is fuelled by too many people touting  about how much money they are making on these trades. These situations are not what we consider to be an investment but are short term momentum trades, meaning that the stocks are not moving due to changes in the underlying fundamental value of the company but are based on technical indicators. These situations often start with a short squeeze, and then turn into a self-fulfilling prophecy in the short run on the way up. But once the upward momentum runs out and stocks start to turn down. Look out below - traders will look to exit positions as quickly as possible and will hit any and all bids on the way down until they are out of their positions,” Morningstar Chief U.S. Market Strategist David Sekera explains.

Put another way, he says, these situations are not quite Ponzi schemes, but share some similarities. “The difference between the two is a Ponzi scheme is specifically created as a nefarious act to defraud investors. Meme stocks don’t start out with criminal intent but lure in unsophisticated investors who may not fully understand market dynamics and valuation. The two are similar because you need either existing or new investors to continually come in and purchase the stock at ever higher prices. Which means that while there will be some investors that make money on these trades, and unfortunately, many investors who are trading these stocks will ultimately end up getting burned and will lose money. Investors will need to be extremely careful in getting involved in these situations,” Sekera says.

He offers four points to remember:

-Rocket ships will eventually burn out of fuel, and you certainly don’t want to be the last one buying.

-To make real money, you need to be one of the first to start selling, and it’s very hard if not impossible to know when that precise time will come. ⏲️

-Many traders of these stocks claim to have diamond hands,  meaning they intend to hold onto the stock no matter what. Yet, once the stock starts to trade down and those traders begin to realize losses, those diamond hands have a tendency to quickly dissipate and the resulting selling pressure will force the stock price to gap down.  

-One might be tempted to take the other side of this trade and short the stock; however, it is extremely dangerous to sell short as the stock price no longer has any connection to the long-term, fundamental value of the company. Remember the old trading adage: ‘The market can stay irrational longer than you can remain solvent’. 

 

©2021 Morningstar. All rights reserved. The information, data, analyses and opinions presented herein do not constitute investment advice; are provided as of the date written, solely for informational purposes; and subject to change at any time without notice. This content is not an offer to buy or sell any particular security and is not warranted to be correct, complete or accurate. Past performance is not a guarantee of future results. The Morningstar name and logo are registered marks of Morningstar, Inc. This article includes proprietary materials of Morningstar; reproduction, transcription or other use, by any means, in whole or in part, without prior, written consent of Morningstar is prohibited. This article is intended for general circulation, and does not take into account the specific investment objectives, financial situation or particular needs of any particular person. Investors should consult a financial adviser regarding the suitability of any investment product, taking into account their specific investment objectives, financial situation or particular needs, before making any investment decisions. Morningstar Investment Management Asia Limited is licensed and regulated by the Hong Kong Securities and Futures Commission to provide investment research and investment advisory services to professional investors only. Morningstar Investment Adviser Singapore Pte. Limited is licensed by the Monetary Authority of Singapore to provide financial advisory services in Singapore. Either Morningstar Investment Management Asia Limited or Morningstar Investment Adviser Singapore Pte. Limited will be the entity responsible for the creation and distribution of the research services described in this article.

Facebook Twitter LinkedIn

About Author

 

© Copyright 2024 Morningstar Asia Ltd. All rights reserved.

Terms of Use        Privacy Policy         Disclosures