Should meme stocks be part in your stock portfolio?

The Story

American Multi-Cinema (AMC) has been in the news since Wednesday, 2^nd of June 2021. Why? It’s the return of Reddit retail investors to the Wall Street. These investors have since the beginning of the year been betting on stocks with little or no fundamental value (value based on financial performance) and raising their share prices to record high levels.

A Little Background to What Has Been Going on With AMC and Meme Stocks in General

The frenzy around AMC actually started in January 2021, when a group of retail traders on Reddit (the popular discussion website) formed a group called WallStreetBets. The aim of this group was to identify stocks that have fallen out of favor with wall street analysts and institutional investors due to weak fundamentals, and drive up their share prices by creating a hype around these shares. This group boast of over 8.5million members.

This initiative gave birth to what we now know as Meme Stocks. Meme stocks are stocks that have fallen out of favor with institutional investors but have caught the attention of retail investors. Some stocks considered meme stocks are: Nokia, Black Berry, Game Stop, AMC etc.

The frenzy around AMC started about the same time there was a frenzy around GameStop. AMC‘s share price at the beginning of January 2021 was $1.98, it traded at $4.96 by the end of the month gaining 151% in January alone. It rose to a high of $62.55 on Wednesday, the 2^nd of June 2021, and as at the time of writing it is trading at $55.79.

AMC’s management is capitalizing on the buzz around its shares to raise capital to fund its business. Before now, the company was a victim of the pandemic. Its financials showed negative shareholder’s equity of more than $5 a share and a debt of over $5bn. The company took advantage of the rally on its stocks to issue 20million addition shares raising over $800million in cash. This funds according to the company’s management will be kept in AMC’s treasury to grow the company. The company’s CEO has noted that they intend to sell 25million more shares.

The company’s market capitalization (market value) has risen from $86mn in January 2021, to $22bn as at the time of writing. Making it worth more than half of the companies in the S & P 500 (the index that tracks the performance of 500 most capitalized stocks listed on stock exchanges in the US).

The Major Players in Financial Markets

There are 5 key players in any financial market: Regulators, Corporates/Government Institutions, Financial Intermediaries, Institutional investors and Retail investors.

All 5 players play different roles and influence the market in different ways.

Regulators: Regulators lay down the rules and regulations guiding listing, investing and trading financial assets in different financial markets. They ensure strict adherence to these rules to protect interest of every participant in the financial market. Examples of regulators are: the Securities and Exchange Commission (SEC), Monetary Authorities (i.e., central banks), stock exchanges etc.

Corporates/Government Institutions: These are the party that provide the financial assets traded in financial markets. For example: corporates offer their shares for sale on the stock market, government institutions sell government bonds and other securities in the fixed income market etc. They influence the market with the type of assets the bring to the market.

Financial Intermediaries: Financial intermediaries play a key role in financial markets as they are the link between the providers of financial assets and the buyers of the assets. Corporates and government institutions sell their financial assets to investors through financial intermediaries. Financials intermediaries are investment banks, brokerage firms, commercial banks, registrars etc.

Institutional Investors: As the name implies are investors with deep pockets. They invest large funds in financial markets and their investing activities sometimes influences the direction of financial markets depending on the size of the market. These investors understand the market and trade/invest from an informed perspective. Examples of institutional investors are pension funds, fund managers, insurance companies, hedge funds etc.

Retail Investors: These are individual investors who execute trades through brokerage firms. They buy assets for their personal portfolios and trade in significantly smaller units than institutional investors. They are not as informed as institutional investors and may not have access to the type of information institutional investors have access to.

These players influence the market in different ways, institutional investors analyze financial markets/financial assets using technical and fundamental tools. They look at the fine details of financial assets in the light of economic realities, make projections about the performance of the asset in the short, medium and long term and then make buy/sell decisions based on their analysis. Investment banks indirectly influence the market by making their research findings on financial assets public and accessible to investors. Investors are supposed to take decisions based on these research reports.

Inadequate financial education and the complexity of these research reports accounts for some of the rebellion we are seeing in the US market. Also, the tradition structures of finance have come under pressure lately. The advent of cryptocurrencies and mobile trading apps is challenging the market as we know it. Recent innovation in finance is giving retail investors a voice and helping them chart their course.

Should I Include Meme Stocks in My Stock Portfolio?

Meme stocks are stocks with little or no fundamentals that have their share price in a rally because of a market frenzy. To properly answer these question lets look back in time to see how stocks that have had a short-term rally performed on the long run.

American International Group (AIG): AIG is an American multinational finance and insurance company. It was established in 1919 and has branches in over 80 countries. The company which started out as an underwriter in Asia, expanded operations, increased its product offering and listed on the New York Stock Exchange (NYSE) between the 1980s and 2000s. Unfortunately, AIG started manipulating its financial results in the early 2000s. Investigations by SEC and other government agencies in 2005 revealed an accounting scandal. The stock’s share price which had soared to a high or $2074 in December 2000 crashed to a low of $630 in 2005, and further declined to $11 at the thick of the financial crisis in 2009.

Though the company has been able to pay back its debts (including the government bail out it got when it hit a liquidity crisis in 2008), its share price is yet to recover. As at the time of writing AIG is trading at $53.07.  

SKYE BANK:  Skye Bank was a Nigerian bank that emerged from the merger of 5 other Banks in 2005. The bank in a bid to expand inorganically acquired MainStreet Bank in 2014. MainStreet Bank was a bridge bank (a bridge bank is a created by the central bank to operate a failed bank till a buyer can be found for the bank) to the failed AfriBank.  The acquisition put Skye Bank as one of the 8 Systemically Important Banks (SIB) in Nigeria.

The acquisition was the bank’s undoing as Skye Bank didn’t have the financial capacity for the acquisition at the time. After the acquisition, financial results from the bank indicated there was trouble within. The introduction of a Treasury Single Account (TSA) in 2015 worsened the situation as a huge chunk of its deposits was from government agencies.

In 2016, the central bank took over the operations of the bank as it has failed to release its full year 2015 financials and quarterly results in 2016. The bank was delisted from the Nigerian Stock Exchange and turned into a bridge bank in 2018. Shareholders were the biggest losers in all of these. Its share price rose by 54% from N0.50k in January to N0.77k before it was delisted in September 2018. Some investors ignored the fact that the bank have no financial result for over 3 years and paid dearly for it.

Investors who ignored the signs of financial problems in these companies totally lost out. GameStop after the rally that saw its share price move from $18 to over $300 in a month also fell to $40 in March 2021. There’s been a lot of insider selling since the AMC rally began, directors exiting their position in a company is a sign of trouble within.

Meme stocks have no fundamental value and so shouldn’t be included in your portfolio.

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