GameStop (NYSE:GME) kicked off the meme stock craze in early 2021, soaring to unimaginable highs and inflicting severe damage to short sellers. Since then, investors around the world have been enamored with meme stocks, or stocks that have a large following on social media.
The rise of GameStop resulted in many new retail investors and traders joining the market. These new participants were immediately drawn to social media meme stock communities that centered on similar interests that they had.
However, joining a meme stock community is an extremely dangerous game. A meme stock community participant is likely to follow or be influenced by the broad investment decisions conveyed by the rest of the group, regardless of a stock’s financial health or risks. This is a classic example of groupthink, which is a psychological phenomenon that occurs when an individual aimlessly follows the actions of a group.
Today, interest in meme stocks spurred by groupthink is still well and alive. Meme stocks have remained a popular topic due to the influx of beginner investors looking to make a quick gain. These stocks, like Meta Materials (NASDAQ:MMAT), are often penny stocks due to the irrational belief that cheaply priced stocks are more likely to have room to the upside than expensive stocks.
Without improvements in trading accessibility and technology, it’s likely that the meme stock revolution would have never materialized. With companies like Robinhood (NASDAQ:HOOD) providing easy access to trading and options, individuals across the world have been influenced to place trades that they might not entirely understand.
“Consideration should be given to whether game-like features and celebratory animations that are likely intended to create positive feedback from trading lead investors to trade more than they would otherwise,” said the U.S. Securities and Exchange Commission (SEC) in its report on the 2021 GameStop saga.
Technology has also allowed individuals to mask their identities within these online communities. So-called influencers can easily spread misleading information to enrich themselves… and face little to no consequences due to their anonymity. Taking advice from an anonymous internet individual with no track record is like asking a preschooler for college advice.
Meme Stocks: AMC Entertainment and Mullen Automotive
Perhaps the best example of this social media groupthink phenomenon is the community of AMC Entertainment (NYSE:AMC) “Apes.” This group proudly touts the #AMCNeverLeaving hashtag, indicating that they will never sell their shares. The movie theater chain has retained its group of loyal supporters, despite shares falling by 80% in 2023. This is likely due to the strong feeling of inclusion within the group, as well as constant messages of support from CEO Adam Aron on X (formerly Twitter).
The concept of never selling a stock is a dangerous practice. Instead of buying and holding forever, investors should instead practice buying and continually verifying. This concept is echoed by Berkshire Hathaway’s (NYSE:BRK-A, NYSE:BRK-B) Warren Buffett, who has stated that one of the reasons he chooses to sell a stock is when the competitive landscape has changed.
Based on the rising popularity of streaming and subscription video-on-demand (SVOD), the competitive landscape for movie theaters and the demand for movie theater tickets has undoubtedly changed.
Another example is the r/MULN subreddit dedicated to shareholders of Mullen Automotive (NASDAQ:MULN), which boasts over 19,000 members. A year ago, the subreddit was a bustling forum full of hope, optimism and, of course, groupthink.
Flash forward to today and MULN stock is now down by 99% year-over-year (YOY). The once-active chatroom has fallen to a low murmur, with most posts criticizing the company or detailing feelings of investment regret. Meanwhile, the electric vehicle (EV) company has initiated reverse stock splits in an obscene cumulative ratio of 1-for-22,500, practically wiping out every single shareholder in the process.
The decline of r/MULN illustrates the devastating effects of groupthink and how it can influence investors to buy or hold a stock that never belonged in their portfolio in the first place. While the groupthink effect in r/MULN has declined, so has the capital that investors entrusted with the company.
Meme Stocks: Zach Morris AKA Edward Constantinescu
In December 2022, the SEC announced that it had charged Edward Constantinescu, known by his persona @MrZackMorris, with conspiracy to commit securities fraud via a pump-and-dump strategy.
In short, Constantinescu — along with seven other members of his trading group, Atlas Trading — had duped their combined 1.5 million followers through the publication of false and misleading information.
The group communicated to their followers that they were buying or holding their shares while they were instead selling them, effectively manipulating their followers to become exit liquidity. This allowed Atlas Trading to sell their shares at higher prices while their followers experienced falling prices. In total, Constantinescu and his cronies managed to net at least $114 million between January 2020 and April 2022.
The story of Constantinescu highlights the dangers of groupthink and stock communities on social media.
Meme Stocks: An Institutional Ownership Analogy
Another way to illustrate the dangers of meme stock investing is the analogy of institutional ownership. When I first began tracking institutional ownership, I searched for stocks with the best financials and the most institutional support. Why? Large investors can provide price support and liquidity. You can think of these stocks as meme stocks with the support of many retail investors. A quick way to gauge for strong institutional support is to search for stocks with 1,000 or more institutional investors, such as Apple (NASDAQ:AAPL).
However, an individual can also find success by tracking healthy stocks with low institutional ownership.
The rationalization here is that investors who buy stocks with low institutional ownership can effectively “front run” institutional investors if the stock turns out to be successful. If you invest in a stock with heavy institutional ownership, or a heavy retail following, it’s possible that early investors have already formulated an exit plan. They can then use you as exit liquidity and dump their shares on you, the new, late buyer.
Meme stock investors are all too familiar with being the late buyer. Don’t be the last one holding the bag when the party’s over. For example, GME stock is down by over 80% when compared to its 2021 high.
Meme Stocks: Final Thoughts
The lesson here is that investors should place little trust in social media stock communities or online personalities that do not have a track record to back up their claims. Additionally, investors should approach anyone that advertises “get rich quick” schemes with extreme caution. Slow and steady is how most successful investors have made their money in the market. Influencers and gurus from unproven social communities should be dismissed and ignored.
After all, it is your own money that you are investing. You, the investor, made the money, so you should decide what stocks to invest in based on your own personal beliefs and due diligence. No one will reimburse you when the stock you invested in based on groupthink gets slashed in half.
On the date of publication, Eddie Pan held a long position in AAPL. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
