Why the Freakout About GameStop?
You’ve most likely heard by now of the GameStop phenomenon — the bizarre saga of an online forum, short-selling hedge funds, app-based trading platforms, and stock market volatility. Now that the dust is beginning to settle, we can see more clearly what this phenomenon actually is, and more importantly, whether it calls for more regulation of financial markets.
If you’re not up-to-date on what happened, watch this short video:
Jennifer J. Schulp — the Director of Financial Regulation Studies, Center for Monetary and Financial Alternatives for the Cato Institute — recently delivered testimony on the subject before the House Committee on Financial Services. In it, she defends “retail investing,” i.e., participation by everyday people in the markets alongside more sophisticated institutional investing.
New technology and app-based trading platforms like Robinhood have enabled a new class of investors to make small, highly leveraged bets. The stereotype has been that a majority of these retails investors are no match for the wit and resources of the “smart” money” on Wall Street. But when a band of video-game-loving GameStop loyalists on Reddit saw the usual suspects short-selling $GME into oblivion, they saw an opportunity to push back and send the stock price sky high. This left hedge funds with short positions (like Melvin Capital) holding the bag to the tune of billions of dollars owed to those to whom they promised to buy back the shares which they lent out at the lower price.
Unsurprisingly, both hedge funds and regulators are now calling for more oversight of retail investment, calling it “market manipulation.” The new investors in GameStop who contributed to the stock price rally say that they’re only doing what the hedge funds have been doing all along — with the roles reversed.
Jennifer joined to explain why restricting retail investors’ access to the markets would be a mistake with likely unintended consequences. Who’s to say that the Reddit mob didn’t have better information than the “smart money”? And what about freedom of contract?
Is this just another example of pitchfork populism run amok, or are we seeing markets evolve into something even better and more efficient at aggregating information?
Find out, on the show of ideas, not attitude.
Listen at BobZadek.com or read the transcript below:
Transcript
Bob Zadek: Good morning, everyone. Welcome to the Bob Zadek show: the longest running live libertarian talk radio show on all of radio, always the show of ideas, never once the show of attitude.
This morning show I thought I’d try something a tad different. I thought I’d have a conversation for the next hour covering a topic that has been in the news extensively — maybe too much. But, from a fun standpoint, not nearly enough. We are going to talk about a topic that is part Kim Kardashian, part morality play, part an exposure of the fact that we have too much or maybe too little regulation in very regulated economic activity in this country, and part just good old fashioned little guys sticking their thumb in the eyes of the big guys. In short, we are talking about the recent episode in American financial history involving a known name: a relatively financially unimportant company called GameStop.
It’s a company that was a bit down in the tooth and kind of uninteresting from a financial standpoint, and was a company which operated mall stores where it sold video games. Its stock was in the tank, more or less. Nobody was paying much attention to it, except perhaps waiting for it to fail, and all of a sudden, GameStop sprung into the news and for weeks and weeks, the financial press talked about little else than the GameStop saga. Of course, the Game Stop saga caught the attention of Congress. Liz Warren was up there issuing press releases, calling for regulation, and it was quite a to-do while it lasted.
Now it’s time to look back and reflect and learn. What are the lessons of the GameStop saga? To help us understand this, I’m delighted to welcome Jennifer Schulp to the show. She is a director of financial regulation studies at Cato. Before that, she spent a good part of her career working for FINRA, the Financial Industry Regulatory Authority. They oversee the securities market, and bring disciplinary actions if there are wrongdoers under the statute and before that she was in private practice in the area of securities regulation.
Jennifer has studied and spoken widely on the Game Stop event and I’m delighted that she was generous enough to spare an hour of her time this Sunday morning to help us understand A) what happened because it’s a fun story, and B) what are the lessons for all of us regular folks that we can glean from the GameStop event. Jennifer, welcome to the show this morning.
Jennifer Schulp: Thanks for having me on. Glad to be here.
LINKS:
- Jennifer J. Schulp | Cato Institute
- Jennifer J. Schulp (@jenniferjschulp) / Twitter
- Don’t Freak Out About GameStop — Reason.com
- Reddit GameStop Incident Could Spur Move to T+1 | ThinkAdvisor
- @CatoCMFA
- Retail Investors Are Revolutionizing the Stock Market. So Stop Calling Them ‘Dumb Money.’ | Cato Institute
The Basics
Bob Zadek: Now there are a couple of key players and we’ll be using their names during the show. I’ll just lay the very basic groundwork for the show, and then have you explain briefly what happened, and then we’ll devote far more time to what the lessons and the consequences of the narrative are. So, GameStop, as I said, was a somewhat uninteresting, publicly traded security and operated mall stores — not the wave of the future. Its stock was much lower than it was at another time. So, here we have this stock, which nobody is really interested in all that much. What happened to bring GameStop and its stock out of obscurity onto the front pages of the financial press?
Jennifer Schulp: Well, it’s important to notice that we don’t know exactly what happened here yet. The facts are going to come out eventually. But at the basic level, GameStop stock suddenly started to rise. It rose a little bit by a little bit, and then very quickly, at the end of January, it started reaching what can be best described as meteoric heights. There could be several reasons why the move started. I think anyone that’s been following the saga has become familiar with a gentleman who goes by the screen name of Roaring Kitty, and also goes by a screen name that I cannot say on air. He had been pushing on a Reddit forum called Wall Street that the idea that GameStop was undervalued. He thought the GameStop had a brighter future than a lot of other people did, and had been encouraging people to invest in the stock.
At the same time he was doing this, there were a lot of people, mostly hedge funds, betting against GameStop future prospects, and they were doing this by short selling GameStop stock. That becomes important because that plays into not only the narrative here of the little guy sticking it to the big guy, but also plays into why the stock price took off at the speed that it did once things started rolling. There was a lot of short selling interest in GameStop. In fact, so much so that there were more shorts out than there were total float of the stock, meaning that people really thought GameStop was going to decrease in value over time.
Bob Zadek: If I could just interrupt for a moment to refresh the memory perhaps or to instruct our audience. The nature of short selling is when a trader or an investor “short sells” a stock, they are selling stock that they do not own. Now that seems a bit shady. How can you sell something you don’t own? Well, the market contemplates that, and the selling investor, the one who is selling stock they don’t own, borrows the shares from somebody else — a very acceptable, conventional transaction.
The mindset of the short seller is to borrow stock today so they can sell it, and when the stock goes down, as they believe it will, will then give back the shares that they borrowed by buying them in the lower market price. So, they will have made a profit by buying low and selling high but doing it backwards, selling high first and then buying low later.
When you buy stocks in the hope of having it go up in price, if you’re wrong, you can’t lose more than your investment. So you kind of have a limit, although it may be a high limit. When you short sell, what makes it risky is that you could lose unlimited costs. The more the stock goes up in price, the more your losses are. Since it can go up to an unlimited amount and unlimited is a high number, then you can’t control how much you’re going to lose, and sooner or later as a stock goes up in price, you’re doomed, and you better cut your losses even though the losses are huge. So the nature of a short-sell is that the more you are wrong, the more you lose with a possible loss being infinity. So, I just wanted to make that point because the pressure on somebody who short sells grows and grows.
Jennifer Schulp: Right. That was a great explanation, Bob, because what’s important here is the concept that they then need to buy the stock back to cut their losses. As the price starts to rise short sellers feel pressure to buy the stock, in order to put a cap on how much they’re going to lose on this bet. When GameStop took off, that meant that short sellers started buying the stock as well, in order to cut their losses. But that just added more demand into our supply and demand of the stock market, which caused the prices to rise even higher.
So, it kind of created a feedback loop, which is one of the reasons that the price took off in a way that you don’t see it. This price rising, plus short sellers needing to buy in order to cut their losses is what’s known as the “short squeeze.” We saw that concept floating around out there in the media a lot over the course of the past month, which is probably something that you never thought about until GameStop became something that we were talking about on a daily basis.
Bob Zadek: So, I know part of the fun of the story was, not only was this Reddit group composed mostly of small investors (that’s a fair characterization), but they were having the time of their life doing so. It was a game to them — a GameStop — no pun intended. Because this caught the attention of the media and the regulators both, tell us about the website under which they were buying the shares — the Robinhood website. The nature of that website was not just a cold trading platform with black and white fonts and nothing special. The nature of the Robinhood trading website itself got the attention of the regulators.
Tell us a bit about the environment in which these small investors were apparently playing at buying the stock of GameStop and others.
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The Role of Robinhood and Zero-Commission Trading
Jennifer Schulp: Robinhood has been getting a lot of press, not just for GameStop, but over the course of the past year. Robinhood and a number of its competitors (Weeble, Etoro, and a number of other new trading platforms) are firstly app-based. So, rather than kind of the old style trading platform, which was designed for you to use on your computer, these are designed to be used on your mobile phone. You can use your iPhone to pull up your trading, and they’re designed much more sleekly and probably, I think much more modern is the right word. They are designed to appeal to a younger demographic.
What has gotten the regulator’s attention here is one, that Robinhood and its ilk (as well as a number of discount brokerages that followed along) now offers zero-commission trading, which means that you can trade as much as you want on their app, and you don’t pay a set commission on the trade. The world didn’t work like that prior to the end of 2019. If you wanted to make a trade you generally paid $3, $5 or maybe less than that per trade but there was a charge every time you wanted to make a trade.
Robinhood offered zero-commission trading, and due to that type of pressure, a number of other trading platforms followed along including some of the big discount brokerages: Schwab, TD Ameritrade, E-trade. In addition to this zero commission trading, these apps (Robinhood included) incorporate elements that some view as more appropriate to games. Robinhood has gotten a lot of attention for having times where confetti goes off on its screen if you’ve made a trade or deposited money into your account. They have lists of stocks that might say these are the top 10 most traded stocks on Robinhood today.
Some of these apps also incorporate things that say, “We see you bought X stock, you might also want to look at A, B and C stocks.” So these apps have a lot of features in common with other apps that you would use on a daily basis. I think successfully they’ve brought in a lot of new people to trading and investing, who otherwise may have been put off by clunkier systems and more difficult to use interfaces or just a general stodginess about trading that might have been not only a pain in the neck to use, but intimidating to newer investors, and boring. I said stodgy — I consider it to be boring as well.
Bob Zadek: So now that that was picked up upon a lot, as if “How dare you convert making money into an enjoyable activity?” How dare you expose trading in stock to have elements of a game or gambling? How dare you make our industry look like a casino? Which, of course, in many ways it is, or it is at least used that way by those people who day trade in securities. So I think part of it was, “How dare you show us to be what we actually are.”
Now you have lived your professional life in the world of this regulated activity. How deep am I overstating the sensitivity of the regulators and the people who do this activity for a living in the securities industry? How much were they concerned about people coming to realize that in this profession, there are elements of both a game and gambling?
Jennifer Schulp: It’s hard to say. I think most of what we’ve heard on this front has been coming from the political angles rather than the regulatory angles. FINRA has been looking at zero-commission trading, and whether or not it’s consistent with broker dealers obligations. FINRA also has announced that it’s going to be looking at these trading platforms to make sure that they comply with current rules, but most of the outrage on this front has been coming from Congress or others that are less familiar with the regulatory system that’s already in place. So, I don’t want to lay too much at the regulator’s feet here. I think there’s one exception to that, which I suspect we’ll end up talking about next, and that’s Massachusetts.
But, there are a lot of rules at play that FINRA enforces that the SEC also has that go to making sure that communications between the broker and the customer are not misleading. Most of that covers what’s happening here already. I’m not sure that this is necessarily something that the regulators are concerned with — with trading being fun or that we didn’t want trading to look fun. But, I certainly think there’s some members of Congress who think that.
Wall Street Bets Reddit Forum Explained: Did They Break the Law?
Bob Zadek: Thank you for correcting me. I look upon regulators and government and tend to lump them together. But, you have spent your career in the regulatory world. You testified before Congress, not before a regulator but before Congress, with a very long testimony, which I’ll have you share with us. So, I was guilty of lumping together two branches of government into one I should have known better.
Now here we are. The stock is going up, and there’s this irony of the trading platform being called Robinhood, with elements of taking from the rich and giving to the poor, the way the legendary Robinhood did. We simply have a bunch of traders who banded together. I’ll ask you to speak to that — whether the banding together, in and of itself is some kind of a market manipulation.
But, we have a band of traders acting pretty much in concert to make buckets of money at the expense of the hedge funds (the insiders, if you will) who had to cover their shorts, and they lost a very large amount of money because the stock increased in price beyond any pre-Robinhood expectation they could have possibly had. Therefore, they didn’t factor in the degree of these possible losses into their calculation.
So at the end of the day, as the factual part of our conversation comes to an end, we have a bunch of day traders who made a lot of money. Now, in anything that we’ve talked about so far, did anybody break any laws or violate any regulation so far in our story?
Jennifer Schulp: Based on what’s publicly known at this point, I would say no. I’ll caveat that because there are things that can have happened behind the scenes here that I don’t have access to that might have constituted violations. There might have been information that was provided on Wall Street bets that was misleading, but was not obviously misleading. When you look at it, there might have been problems with how the hedge funds were shorting the position. Again, I don’t know the facts that underlie any of that at this point, but what we have here are a bunch of people on Reddit who got together and decided to buy the stock, and the stock went up. We don’t have a legal problem here.
Bob Zadek: Tell us what Wall Street Bets is, and where it fits into the story?
Jennifer Schulp: Wall Street bets is the Reddit forum. It’s a virtual meeting place of sorts where Roaring Kitty and others talk about this stock. There are obviously other places where people were talking about the stock, but Wall Street Bets was kind of the hub for activity with people getting excited about GameStop stock. It was an interesting place. It did not pop up specifically for GameStop. Wall Street Bets has been a functioning forum for quite some time.
There was a community of people there that shared stock tips with each other and shared their research, and that’s where this started. The way I see it, the fact that people were talking online is no different than if this were a cocktail party or some email or a conference of investment professionals talking about stock picks.
Bob Zadek: So, there was nothing inherently wrong with a bunch of investors saying let’s all buy GameStop stock today, and let’s all put a bunch of money and take long positions on the stock. Let’s all do it together. We know by doing so, this price of the stock will go up and then when we sell we’ll make money. That activity while it might sound like some form of market manipulation, that activity activity is not per se unlawful without more facts.
Jennifer Schulp: That’s right and I think that we get tripped up a lot, particularly when we’re thinking about this and when we’re reading news stories about the word manipulation because the day-to-day use of the word manipulation and the legal definition here tend to be different things.
Whenever I buy stock, I hope that it goes up. If I’m buying stock at the same time that there’s good news about the company or some research came out saying that this company is a good buy, I’m buying that stock at the same time as other people also trying to make it go up, because my demand could help move the price up. It doesn’t generally because I’m small. But really, anytime we’re buying stocks, we’re hoping or trying to change that price. That’s why the legal definition of manipulation isn’t so loose. Traditionally, and codified in some sections of securities laws, manipulation requires some sort of false, misleading, or deceptive behavior, in order to be a legal problem. I haven’t seen any evidence thus far out in the public domain, that there was anything fitting that legal definition of manipulation here.
Zero-Commission Trading In Depth
Bob Zadek: You mentioned a short while ago that one of the defining characteristics of Robinhood is that it offers commission-free trading, and you mentioned very briefly a few minutes ago that that at least got the attention of the regulators. It’s interesting that this is yet another example of a consumer commodity (I think of Google with the free searches as another example) where a service is examined for possibly misbehaving by having their business model in such a way that the service is free to the consumer. Now what is there about free commission’s per se that would even get the attention and not the praise of regulators?
Jennifer Schulp: Well, commission-free trading is an interesting beast, because when you get a product for free, the person providing the product needs to make money somehow. So, I would say the typical statement now is that if you are not paying for the product, you ARE the product — which is familiar to us with Facebook, Google, and others. But for commission-free trading with Robinhood and others (Robinhood to a larger degree) makes money off of the trading by selling it, called order flow. In other words, another entity executes the trades that you want to make.
That is a practice that the SEC has looked at multiple times over the past 20 plus years and has blessed. You’ll see payment for order flow is what it’s called. The press has actually gotten pretty good about using the real term here. The SEC has looked at it several times and said that’s not a problem.
It presents a conflict of interest that brokers need to manage because when the broker is getting paid for the order, the broker might not be incentivized to pick someone to execute the trades that’s going to give the customer the best price. That’s what’s known as the duty of best execution. So, there’s a potential conflict between a broker offering zero commission trading and giving the customers the best price for their trades.
Again, the SEC has looked at this multiple times over a number of years and said, that’s fine, you have to manage the conflict. So, commission-free trading shouldn’t be a problem. But people need to understand that the broker is making money and is making money off of their trading. They’re just not paying an upfront commission to do so. It shouldn’t be a surprise and people ought to be able to have the freedom and ability to make a choice to use a broker that offers that type of system.
Whose Side Is Congress On?
Bob Zadek: Now, the GameStop saga got the attention of Congress and you were privileged to testify before Congress. Congress said, “This requires some attention, because it’s in the media and if it’s in the media, we want our name to be part of the story in a good way.”
That’s my cynicism. Forgive me. So you get invited because you are an expert in securities regulation, to testify before Congress. What was the stated reason for Congress thinking they ought to look at this at all? What were they concerned about? and what kind of inquiry did they make of you during your five and a half hours of testimony before Congress? Did they accomplish what they wanted to accomplish?
Jennifer Schulp: I think it depends on what each individual thought the purpose was here. I think as you said at the beginning of our conversation, there was a little bit of something for everyone here in this story. There were a lot of differing purposes by members of Congress in having the hearing and in calling the witnesses that were called. There was one section of the saga that we haven’t talked about to this point and that was the subject of a lot of questioning during the congressional testimony, which was the fact that when GameStop’s stock price rocketed, there was a day that Robinhood and other brokers restricted customers’ ability to buy GameStop stock.
That caught the attention of a lot of members of Congress, actually on both sides of the aisle, because there was concern that Robinhood may have been improperly influenced by big Wall Street players. There was concern that by stopping the trading, individual investors lost out on the ability to trade. So, that was a topic of a lot of interest from members of Congress on the Democratic and the Republican side during this hearing.
But first let me get back to the other question about whether Congress accomplished what it was trying to do in that hearing. Five and a half hours of testimony and I can say thankfully that I was not answering questions for most of that five and a half hours, because that is a long time to be testifying, but it’s difficult to say that the hearing really accomplished one unified goal. There were a lot of different types of questions asked. The committee Chairwoman, Maxine Waters, had announced at the beginning of the hearing that this was the first in a series of hearings devoted to the GameStop phenomenon, so to speak.
So, the purpose here was just trying to get out some facts. I think most of those facts had already come out in the media by the time the hearing took place. So, it was allowing a lot of members of Congress to have their bite at the individual fact players, and that definitely was accomplished.
Bob Zadek: Who did Congress feel were the villains? And who if anybody were the heroes? Was there any consensus at all as to whether there was a problem? And if so, was there a bad actor? Or were they just hoping for tidbits, trying to learn or wanted some media attention?
Jennifer Schulp: Well, there was definitely motivation for all of those things. I think when you look at the hearing as a whole, it wasn’t clear that there was any kind of consensus view coming out of it. What I think was clear after five and a half hours at the hearing is that Congress is not interested in quickly proposing legislation here. They’re not looking at a quick regulatory response, which actually to me is heartening to hear, that they’re going to spend some more time thinking about this rather than been rushing to some sort of reactionary regulatory decision.
But, I think it’s difficult to say that you saw any sort of real consensus. They spent most of their time talking to the Robinhood CEO. So, I think to the extent that there was any consensus, it was the consensus that they needed to ask him a lot of questions.
The Invisible Hand of Wall Street Conspiracy Theory
Bob Zadek: With the reference to the Robinhood CEO, and going back to your explanation of what the business model is for commission-free trading at the retail level, it was the fact that Robinhood had another institution executing the trades and that triggered regulatory events about Robinhood having the credit to backup the trades. So, that was kind of a second-tier issue. I think you would include the issue that Wall Street was getting the regulators and other big companies to snuff out the trading ability of the Robinhood traders — that was much ado about nothing, wasn’t it?
Jennifer Schulp: Yeah, I do tend to think that was much ado about nothing. The real problem that existed there was not with Citadel. Citadel’s involvement (according to some of the theories) was that Citadel jumped in to try to stop retail traders from being able to continue to buy GameStop.
But the problem there was actually, as far as we’d seen the public information, was that the entity that handles settlement of stock trading — which is something we never talked about in the media because it just happens and it’s not something that the average investor needs to be worried about — that entity requires brokers to put up collateral during the time that it takes trades to settle. Right now it takes trade two days to settle. And there’s calculations that happen as to how much each broker who’s engaged in this needs to put up.
Well, because the price of GameStop had gone through the roof and was very volatile, that meant that the clearing house (the DTCC, which you might have seen thrown around) asked Robinhood for a lot more money for collateral. Robinhood didn’t have that money available when they asked for it. So, in order to decrease the amount of money that DTCC was asking for, Robinhood, proposed stopping investors from making new purchases in GameStop. DTCC said that that would reduce the amount of collateral. Robinhood had that much collateral on hand, put it up and was able to continue trading, but in that more limited fashion.
That explanation makes sense to me. It makes less sense to me, some of these crazy theories that have been floated about the Invisible Hand of Wall Street stepping in to squash the little guy here. But, there was a lot of concern about whether individual investors had been unfairly hampered in trading on Robinhood due to these decisions that were made.
Bob Zadek: A minor observation. I don’t think Wall Street’s hand (your metaphor) is all that invisible. And I think it’s very visible, and strongly felt very often. But we like to pay homage to Adam Smith.
Jennifer Schulp: Yeah. Invisible as in we’re not quite sure which Wall Street entity might have been doing the pushing.
Bob Zadek: Sorry, anytime you want to make even indirect reference to Adam Smith on my show, it’s always welcome. You never have to apologize for any reference to anything Adam Smith has ever said.
Lessons Learned From the GameStop Saga
Bob Zadek: This whole event was singular; it hadn’t really happened quite this way before. Sure, stocks are going up and down and they have been bubbles. This was hardly that. But it was in many ways singular, and captured both the ink and the imagination of those people who pay attention to the financial markets.
So, my question is, are there lessons for anybody? Did anybody get smarter as a result of this happening? And by anybody I mean regulators, Congress, day traders, speculators, gamers disguised as stock investors, hedge funds, or the like. Who might be doing anything differently or may be more encouraged or less encouraged by the event?
Jennifer Schulp: Yeah, I’ll take two groups that I think have learned some lessons here. One of them are the hedge funds and big Wall Street players. The lesson is in risk management, and making sure that you are considering retail investors and social media and some corners that you might not have traditionally looked at when you are making your investment decisions. What was singular about this event was that it was a short squeeze initiated by retail investors. I’m sure that the hedge funds here who held massive short positions in GameStop hadn’t been focused on the fact that there might be pressure from the retail sector that they needed to be concerned about. I think that lesson was learned pretty quickly. I think that we’ll see some changes made in how the short investors and other large investors view retail when they’re evaluating the risks in their own portfolio.
I think the other group here that’s learned are retail investors. I think first they learned that there’s some power in being able to do this in a smaller cap stock. But for me, what I hope they’ve learned is a little bit about investing by doing. I think we’re fortunate that we have not seen very many stories at all about individual investors who’ve lost big in GameStop. That’s not to diminish the fact that some people did lose, and people are going to lose when they engage in this type of behavior.
But, I was heartened that a lot of people who lost understood the risks. There’s an article in the Wall Street Journal that highlighted some of what they consider to be the bigger losers from the retail sector here. Most of them acknowledged that they understood the risks and they understood the risks in day trading and speculating and investing in a stock that’s on a massive upward swing in momentum.
I hope that retail investors who have jumped into the markets in the past year are learning here about some of the risks that are attended with this type of speculation. Learning by doing is great. I hope we see some more learning by doing in the retail section.
Bob Zadek: Now the word “derivatives” popped up a lot during the saga, and it pops up a lot in any securities literature. You will see the phrase that a stock is undervalued or overvalued, that stock price is too high for that security, or too low. Now, I’m going to sound naive, hoping and delighted if you would correct my naivete. Focusing on the word value as applied to a security — that value doesn’t mean what the owner thinks something is worth. Just like when I apply for a job and I say I want 100K a year — that’s my opinion as to what a year of my time is worth, but my opinion doesn’t matter all that much if nobody is willing to pay it.
So, the point is, value is a bilateral decision. It’s the value that the seller thinks something is worth, and that exactly coincides with what a buyer thinks it’s worth when those decisions coincide. That fixes its value exactly. So, value is not what somebody thinks, it’s what will cause a sale to take place. With that introduction of the word value, how could a stock ever be overvalued?
That is to say, Jennifer, and I’m asking you, because this is your world. You have seen the phrase, stocks are overvalued or undervalued. That cannot mean exactly what the word value means. I’m not asking you to give stock advice, obviously. But in your world, what does value mean, when somebody says a stock is undervalued or overvalued, because that was used every minute of every day in the Game Stop reporting. Help us understand value when applied to a security?
Jennifer Schulp: Sure. It is a funny word to use, because you’re right, and the market here sets the price. The market decides what a stock price should be based on where people are willing to buy and sell at the price where buyers and sellers meet. When you hear value when we’re talking about securities, it’s a much more squishy term, that refers to the prediction that someone has in looking at a company’s earnings revenue, expected future earnings, to determine where they think someone will value or want to buy that stock in the future.
It’s a pretty subjective number, and you’ll see (GameStop notwithstanding) all of the big Wall Street firms have put out research on stocks. They have kind of a band of what they think a price target is for that stock and where they think the stock should be trading around, and whether it’s something you should buy now, something you should sell, or something you should hold on to.
Even the best research minds in the game don’t always agree on what they think that stock’s value should be. They’re operating with models that they’ve tested and I think that the GameStop phenomenon should be a wake up call to tell those that are treating value and “fundamentals” as some sort of gospel in truth as to what a company should be trading at, that they might be missing information. Other factors might also be affecting what people are willing to pay for a stock. So that’s a long way of saying value is subjective.
Bob Zadek: In other words, when one concludes a stock is undervalued (an absurd concept, as I said), but when one concludes that, that is a two step conclusion. Step number one, you try to determine what certain arithmetic facts will be in the future, earnings per share, yield on assets, whatever the calculation is, you make a calculation for what some numbers will be sometime in the future. That’s arithmetic, and that requires you to understand the business.
Step two, you say, what will the hypothetical marketplace do with that information in the future? That’s the key. If you’re right about the first, but the marketplace in the future is unpersuaded by it, you were right in what the company will do in the future, but wrong about predicting how the market will react. So, there’s an element of mind-reading in this whole process that’s kind of weird to me.
Now, Jennifer, help our friends out there understand how they can follow the great work that you do over at Cato, and tell us what projects that you’re working on?
Jennifer Schulp: Thanks so much for listening to me today. As Bob said, I’m at the Cato Institute, specifically in Cato’s Center for Monetary and Financial Alternatives. I do a lot of my work on retail investing at the moment and look for more for me on that. All of my work is available on the Cato Institute’s website cato.org. But, you can also follow me on Twitter and that’s @JenniferJSchulp. That’s, that’s where the best place to find my work is.
Bob Zadek: Thank you so much for giving us an hour of your time and for your insights on this great fun story. It’ll live forever in time.
