Should you invest in meme stocks ?

Investing in meme stocks requires a lot of caution because of the high volatility of prices.

Since the GameStop phenomenon, meme stocks have become very popular on the stock markets and particularly among traders. They are part of a new phenomenon that is shaking up the fundamentals of stock market speculation. Indeed, the prices of these stocks can rise spectacularly, thanks to the support of internet forums. What are meme stocks and how to take advantage of them?

What is a meme stock ?

The term "meme" comes from the ancient Greek and literally means "to imitate". In today's context, a "meme stock" is an asset whose price is strongly indexed to a concept or idea that is spreading rapidly on the Internet. The speed of the phenomenon is reflected in the evolution of GameStop's (GME) share price in January of this year. 

The American video game store chain saw its share price rise by 1900% in the space of a month. From January 25 to 27, GME stock went from $76 to $350. This trend was propelled by communities of individual traders, including on the Reddit forum r/wallstreetbets. Nevertheless, GME's stock price fell almost as precipitously as it rose. This means that after GME's share price peaked, retail investors cashed in their gains and then moved on to other stocks.

How to recognize a meme stock

A meme stock is above all a social phenomenon that is based on the rapid communication of an investment idea or concept in online forums and websites. Its rise is mainly due to the democratization of stock market investing, which has been catalyzed by online trading tools, free transactions and more accessible asset shares.

However, these shares are mainly for companies that are in difficulty and are looking for a recovery plan. They are thus assets that are generally sold short by professional investors, because their issuing companies have not been able to make enough profits. These are shares with pessimistic forecasts, with a lower expected price. This is the case with GME, for example, which has not reported any profits for the last 3 years.

In cases similar to GME, it is mostly small companies that are well known to the general public that are taking advantage of the stock phenomenon. These include brands that are present in shopping malls, such as GME, AMC Entertainment (AMC) and the retailer Bed, Bath & Beyond (BBBY). However, there are also companies like Blackberry and Nokia, which are known by consumers for their older products. In order for even a stock to emerge, however, it is essential that these smaller brands have the support of a large number of online investors.

Are meme stocks sustainable ?

Currently, the community of investors interested in this type of shares continues to grow. In fact, on Google, searches for meme stocks have doubled. In addition, r/wallstreetbets has also seen a 5-fold increase in the number of subscribers compared to January. Currently, the platform has more than 10.5 million members. Moreover, the democratization of the stock market is booming with social trading platforms and brokers that apply ever lower fees, or even free. We can thus conclude that the meme stock phenomenon will last and that new stocks will surely emerge.

What are the risks of investing in meme stocks ?

Investing in small companies is generally riskier than in large publicly traded firms. This is because they are less diversified and have less capital. In addition, the lack of earnings makes it impossible to apply the usual calculations to value them. Furthermore, meme stock prices are characterized by high volatility. Indeed, the price variations are much bigger than normal assets. Moreover, they strongly resemble the trends that some crypto-currencies have enjoyed since the beginning of the year.

How to invest in meme stocks

In view of the risks mentioned above, investors should be very careful if they wish to invest in meme stocks. This includes diversifying investments across several asset classes and stocks. To unearth this type of opportunity, you should refer to forum threads and comments on investment news sites, such as Reddit and r/wallstreetbets. However, you need to know how to filter the information, as almost 98% of the stocks mentioned there will surely result in losses. Thus, it is necessary to refine your plan of action to go through the publications and posts to determine the most reliable ones and the feelings of other investors. To better filter the discussions, here are some tips:

  • Make sure that the account that posted the message is not a new profile, a fake account or a bot
  • Go back into the investor's publication history and compare their past choices with what has actually happened in the markets
  • Find out about the stocks themselves and the companies targeted by the publications
  • Focus on second-tier companies that are being overlooked because of their revenue levels and the ferocity of their competitors