What is a meme stock?

Shares of a business that have amassed a cult-like following online and on social media platforms are referred to as meme stocks. Through stories and discussions detailed in forum threads on websites like Reddit and posts to followers on platforms like Twitter and Facebook, these online communities can go on to create buzz around a stock. 

Meme stock communities can therefore have a significant impact on the pricing of those shares by working together, for example, by starting short squeezes in heavily shorted names. As a result, meme stocks can appear to be overvalued in relation to their fundamentals while continuing to trade at high levels for extended periods of time thanks to the support of the meme stock community.

Meme stock forums have also created a dictionary of informal slang and market terms such as “diamond hands” (strong hands that will not even sell on dips), “tendies” (profits), and “to the moon” (returns extremely above average).

Understanding Meme Stocks

A meme is a concept or aspect of popular culture that circulates and reproduces in people's minds. As the internet and social media evolved, memes became more and more common and relevant. This enabled individuals to quickly share amusing, fascinating, or sarcastic videos, images, or articles with others around the globe. Sharing such things could have a quick and multiplying effect that makes them go viral.

However, it wasn't until the Reddit community “r/wallstreetbets” in 2020 that meme stocks started to take off. WallStreetBets established a reputation for having a unique and frequently rude tone, unlike its forerunners and other investing message boards. Furthermore, users collaborate to select target stocks on this forum and others that have since appeared, promoting them while investing their own funds in the process. For the most part, the marketing of meme stocks entails buying and holding with the above-mentioned strong hands even after the price jumps, unlike internet “pump-and-dump” operations that are meant to mislead naïve investors.

The First Meme Stock

The YouTube Roaring Kitty published a viral video in August 2020 outlining the reasons why shares of physical video game retailer GameStop Corp. (GME) could increase from $5 to $50 per share. In the video, he explained that the stock had some of the highest short interest on the market, primarily due to short positions held by hedge funds, and that these funds would have to cover their positions in the event of a significant short squeeze, which would cause the stock to rise significantly.

The price of GME shares then skyrocketed to about $500 amid a frenzy of short-covering and panic buying in January 2021, signalling the start of the short squeeze that The Roaring Kitty had predicted.

Certain considerations

While the meme stock phenomenon has benefited individual investors, day traders, and brokerage platforms, businesses have also profited from it. AMC Theaters CEO Adam Aron took advantage of the elevated valuation and engaged in a series of secondary (follow-on) offerings in 2021, raising more than $1.5 billion from hungry meme stock buyers in the first quarter of that year due to the sky-high prices and persistent demand for shares among individual investors.

Referring back to GameStop, a secondary offering of 8.5 million additional shares at an average price of more than $200 per share was used by the company to raise approximately $1.7 billion in 2021.

Meme Stocks and Short Selling

Meme stocks have a tendency to be extensively shorted, especially in the beginning. This implies that there is a high level of short interest in the stock or that a big percentage of the company’s shares have been sold short.

When an investor/trader sells shares they do not own with the hopes of buying them later at a cheaper price, that is known as short selling. Therefore, it is a wager that prices will fall. In order to sell the shares, the seller must borrow them from someone who is long the stock. There are fewer shares left to borrow when more and more shares are sold in this approach. Even the most driven short seller might not be able to borrow shares once a stock itself becomes difficult to borrow.