Why do Meme Traders Target Distressed Companies?
Of all the Zero Interest Rate Policy (“ZIRP”) phenomena we’ve seen over the last decade, none has captured the hearts and minds of investors and traders of all types worldwide the way meme stocks have.
A meme stock isn't characterized by financial fundamentals but rather by the hype generated by online retail investor communities. It goes without saying that their valuations are not grounded in traditional financial logic. The influence of online communities (such as Reddit) is what drives prices.
Online communities target specific companies and coordinate their purchases to drive up prices.
Factors that have contributed to the rise of meme stocks include:
Commission-free trading platforms like Robinhood
Mobile trading accessibility
2020 stimulus checks
If you follow markets at all, none of what we’ve said so far comes as a surprise.
Here’s the thing. ZIRP is dead. Stimmy checks are long gone.
Meme stock traders are still around, pouncing on the flailing bodies of distressed companies in their weakest moments.
Subreddits, particularly WallStreetBets, have played a massive role in this trend. Reddit has a platform of user-generated content, and its communities (subreddits) focus on various topics, including investing. WallStreetBets, r/stocks, and r/investing are prominent investment-focused subreddits.
StockTwits is another platform where investors share ideas. The majority of these platforms' users are young males with some college education and modest investment funds.
Historical Parallels
Meme stocks have similarities with the stock pools of the 20th century, where the price of securities was manipulated for insiders' benefit.
Past attempts to manipulate stock prices include efforts to "corner" the market, where an investor tries to gain so much control that they can influence prices. Notable examples include Jay Gould and Commodore Vanderbilt's attempts in the railroad stocks and the Hunt brothers' attempt with the silver market.
Bankrupt Companies
The most entertaining (and infuriating for some) aspect of the meme stock phenomenon is that meme traders take aim at distressed or even bankrupt companies. WeWork, having already spent years being the butt of jokes among online finance communities, recently joined in this trend.
WeWork stock soared over 160% after announcing that the company may not be able to survive. WeWork's stock is down 97% since its 2021 SPAC deal, with its market cap falling from $9 billion to $300 million. The company, which hasn't turned a profit and has lost $16.4 billion since 2018, faces challenges from the growing work-from-home trend and issues in the commercial real estate sector.
The trend of boosting stock prices for financially unstable companies began in early 2021 with GameStop and later affected AMC Entertainment. This price inflation, primarily fueled by retail traders, can offer struggling companies a chance to raise funds by selling shares at inflated prices.
Why do meme traders go after dying companies?
Let’s look at a few examples
Tupperware
In May 2023, Tupperware hired Moelis & Co. for “strategic advice” (translation: a restructuring). This came after the company delayed its 2022 annual report due to accounting misstatements in prior years. Tupperware was facing a liquidity crunch and needed new financing.
Perhaps feeling encouraged by the AMC stock rally, meme traders sought out their next target. Tupperware's stock rose nearly 300% in the last month, supported in part by reaching a debt restructuring deal. The stock is one of the most popular discussions on Stocktwit. As of July 15, 27% of Tupperware's public float was sold short and the stock was trading at $0.65.
Bed, Bath, & Beyond
Bed, Bath & Beyond Inc shares experienced a significant rise in trading on January 9, 2023 spurred by retail investor speculation that the underperforming home goods retailer could be a likely buyout candidate. The stock saw an impressive 35% increase to $1.77, marking its most significant single-day percentage boost since Aug. 8. By mid-day, trading volumes reached $114 million, almost equivalent to the firm's total market cap of $157 million, based on Refinitiv's data.
Online discussions about a potential merger and acquisition deal for the company have been rampant on platforms like Reddit, mirroring the "meme stock" trend of 2020. This trend witnessed stocks of distressed firms, like GameStop Corp (GME.N) and AMC Entertainment Holdings (AMC.N), skyrocketing due to heightened attention on platforms such as WallStreetBets.
The value of Bed, Bath & Beyond's stock plummeted almost 50% the previous week after the company hinted at potential insolvency and the possibility of seeking bankruptcy. Furthermore, a Reuters report indicated that the company might pursue bankruptcy protection soon.
For years, Bed, Bath & Beyond has grappled with dwindling sales, facing stiff competition from giants like Amazon (AMZN.O) and other competitors. Common criticisms from investors include the retailer's cluttered store layouts and an excessive dependence on discount coupons. In 2022 alone, the company's shares dropped by 83%.
Last week's company filing revealed an anticipated net loss of $385.8 million for the fiscal quarter ending in November, which includes $100 million in impairment charges. Currently, out of 13 analysts tracking the company, three suggest "hold," eight advise "sell," and two have given a "strong sell" rating. The average stock price target is now $2, reduced from $3 the previous month.
Yellow
Shares of Yellow Corp, a U.S. trucking company, saw a dramatic increase, surging over 67% after its value more than doubled in a previous session. The Teamsters Union revealed that Yellow had stopped operations and was declaring bankruptcy. Despite its financial struggles, the company's stock became highly popular among retail traders.
Why Troubled Companies Become Targets
There are a number of factors at play that make distressed companies particularly good targets for meme stocks.
Short Squeezes: Many struggling companies have significant short interest. Short sellers are betting that the stock price will decrease. Meme stock traders mobilize these companies to initiate a short squeeze. If they buy in large enough quantities, the stock price goes up, and short sellers may be forced to buy shares to cover their positions, driving the price up even further.
Social Media and FOMO: Platforms like Reddit, Twitter, and Discord allow retail investors to rally behind a particular stock, amplifying its popularity. Fear of missing out (FOMO) can lead to rapid buy-ins from a large number of traders, pushing the price up.
Rebellion Against Institutions: Part of the appeal of investing in struggling companies is the David vs. Goliath narrative of small retail investors vs. large institutional investors or hedge funds. Many meme stock traders see themselves as fighting against a system that is rigged in favor of big players. That doesn’t mean institutions aren’t participating in or perpetuating trades surrounding meme stocks.
Speculation Over Fundamental Analysis: Traditional stock investing emphasizes a company's fundamentals, such as its financial health, profitability, and growth potential. Meme stock trading prioritizes fuels momentum and sentiment over these fundamentals.
Visibility: As a company nears bankruptcy, it often gains more media attention. This increased visibility can make the stock more appealing to retail traders looking for opportunities. Meme stocks also tend to be companies that have recognizable brands among consumers (although meme traders appear to be evolving).
Gamification: Modern trading apps, with their easy-to-use interfaces and features, have gamified stock trading, making it feel more like a strategy game for many users. This has further encouraged speculative trading.
Potential for High Returns: The volatility associated with these stocks means there's potential for massive gains in a short amount of time. However, there's also a significant risk of substantial losses.
This is normally the part where we would tell you where to look for the next meme stock. However, we have not spent enough time in these online communities to have a pulse on what meme stock is up next. Were we interested in becoming meme stock aficionados, we would maintain a list of companies approaching distress, rank them in order of visibility to retail (presence in the consumer market), then monitor discussions on online communities such as Reddit, Stocktwit, and Twitter based on this watchlist.
Disclaimer: We are not financial advisors. This content is for educational purposes only and merely cites our own personal opinions. All analysis, including valuation, debt, liquidity, etc. is illustrative in nature and subject to revision.