December 17, 2021

The recent GameStop episode on Wall Street serves as a powerful reminder of the difference between investing and gambling. Gamblers sometimes win big, but over the long term, it pays much more handsomely to be an investor.

No experienced investor is surprised that GameStop stock has lost more than 80% of its value from the peak a few weeks ago. While we don’t know where the price will finally settle, there is no way that this company was worth tens of billions of dollars over the long run.

Even if GameStop has much better prospects than the short sellers believed, fundamentals still matter, and share price is ultimately going to reflect cash flow. By catching short sellers in a “squeeze,” retail investors found another path to drive the share price up. But a short squeeze can’t last forever.

For a while, the retail mob experienced the powerful rush that comes with seeing massive returns on their investment. Their euphoria encouraged many more to join the frenzy, in a self-reinforcing cycle. Unfortunately, this bubble was always bound to burst.

Those who got in and out early had the chance for massive profits. Many others are now left holding the bag, with massive losses. This is just like countless speculative bubbles that have suddenly inflated and popped over the years.

Real investing requires real analysis. What are the prospects for cash flow and growth from this asset? What are the opportunities and risks? How well prepared is the management team to navigate that landscape? How does this investment fit into a broader portfolio that improves our total returns, relative to our total risk?

GameStop’s boosters were either gambling that they could get out before the crash, or they had some extreme beliefs about the company’s ability to grow and improve profitability. Unfortunately, both of those are common errors that cause inexperienced investors to lose to the professionals in the long run. As with casinos, over time, the house always wins.

This strange story showed us that retail investors have more power to coordinate and move markets than ever before. But as the great Warren Buffet once said, in the short term, the market is a popularity contest. In the long term, it’s a weighing machine. Newly empowered investors should remember that the kind of long term returns that produce real wealth come from fundamentals and a clear, cohesive investment philosophy.

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