Workers who’ve spent decades building a nest egg might look at the meteoric rises of GameStop and other speculative stocks and draw a lesson: Invest in the right company at the right time and make your fortune overnight.
It’s the wrong lesson.
The GameStop (ticker: GME) share price has shot far beyond any reasonable valuation, analysts say. The company faces big operational challenges to pull off its new e-commerce strategy. GameStop’s share price will eventually come back to Earth, and it could be a brutal trip down for investors left holding the bag.
Investing in speculative stocks that have suddenly become market darlings isn’t a great strategy for long-term investors. But it’s a particularly poor one for anyone in retirement or close to it. Investors in their 20s or 30s—or even their 40s—have time to rebuild their investment portfolios after an ill-considered bet. That’s not true for older investors, particularly ones who already have begun drawing down their retirement savings.
“If you’re wrong, you’ve got to come up with the money elsewhere or dramatically change your lifestyle,” says Andrew Feldman, a Chicago-area financial advisor. “If you have a retirement portfolio that can finance your lifestyle, you’re foolish to gamble with that.”
The forces that have propelled GameStop’s share price upward are mercurial. As a brick-and-mortar retailer selling game equipment, the company has seen its revenue squeezed in recent years and became a favorite target of short-sellers. But GameStop ignited the interest of individual investors with its plan to close hundreds of stores amid hopes it could dramatically increase its online sales.
In recent weeks, individual investors, coordinating their actions online, have piled into GameStop and pushed up its shares. That has created a short squeeze, where short sellers have had to purchase shares of GameStop to cover their bets. GameStop, which was trading at under $20 a share early this year, has seen its share price climb above $450 at certain points in recent days.
Small investors have made fortunes from GameStop’s rise—while Wall Street hedge funds that were shorting the stock have taken big losses. Small investors have piled into other embattled companies that were favorites of short sellers, like AMC Entertainment Holdings (AMC) and Vir Biotechnology (VIR), pushing up their prices, as well.
Larry Swedroe, chief research officer for Buckingham Strategic Wealth, says investing in small, troubled companies is the financial equivalent of buying a lottery ticket. In the aggregate, they tend to underperform compared to the broader market.
“The vast majority of investors lose their shirts, depending on how big you play,” he tells Barron’s.
Swedroe and other market experts say that the current market mania is the latest in a series of bubbles dating all the way back to the South Sea Company in the 1700s. Almost all of these bubbles ended badly.
In the 1960s and 1970s, American investors became fixated on the Nifty Fifty, a group of 50 blue-chip companies that often had lofty price-earnings ratios over 50. They crashed, and the market didn’t really recover until the early 1980s.
In the late 1990s, the dot-com boom lifted the stock market to new heights before a brutal crash. “If you invested in all the internet stocks and held them until now, you probably would have matched the S&P 500, ” says William Bernstein, a financial theorist who’s written several investing books. “It’s just along the way you would have lost 95% of your money.”
Bernstein says that people love stocks with stories, making bubbles inevitable. “There are few narratives that are more intoxicating than the notion you can become effortlessly rich by trading securities,” he tells Barron’s. “It beats sex any day of the week.”
In recent years, many investors have become infatuated with the electric car marker Tesla (TSLA), pushing its share price into the stratosphere. Feldman, the Chicago advisor, says he has tried to steer his clients away from investing too much of their money in Tesla, or any single stock.
But he added: “Tesla is making a product where value could come.” By contrast, he believes that GameStop will continue to see its business shrink.
Feldman doesn’t invest in individual companies for his clients. Instead, he favors low-cost index funds that capture big chunks of the market.
But even financial advisors who dabble in single-company stocks usually steer clear of ailing companies.
Financial advisor Jim Bradley in Bangor, Maine, puts roughly a third of his clients’ equity investments in companies that are generating above-average returns on equity but still have affordable price-to-equity ratios. In January 2016, he bought GameStop at $27 a share, because it was still generating good cash at the time, paid a hefty dividend, and appeared to be underpriced compared with peers.
But in December 2016, as Bradley became more concerned about GameStop’s prospects, he sold off the position for roughly $26 a share. He says his investors still came out slightly ahead, after including dividends paid by GameStop.
He says he doesn’t regret selling GameStop, even though the stock is worth far more today, because it no longer fit his investment guidelines. It has come up in recent conversations with investors, he says. “A couple of customers with a wink and a nod have remembered we held it and said, ‘Gosh, maybe he sold it too early.’”
Write to us at email@example.com