PRTY… BBBY… MULN… There’s a Meme Stocks Investor in All of Us

Stock Market

This week, shares of low-quality meme stocks jumped on renewed retail interest. Struggling chain Bed Bath & Beyond (NASDAQ:BBBY) jumped 240%, while Party City (NYSE:PRTY) would rise 90%.

And having followed these stocks for the past several years at InvestorPlace, here’s one thing I’ve learned:

People love making tons of money. (And preferably with little effort).

Online stock forums are full of those seeking the “I-Win” button. The goose that lays the golden egg. The knowledge they will have more money in their lifetime than they can comfortably spend… or at least knowing they will never run out of cash in old age.

There’s no shame in asking for more, either. We put in our 40-hour workweeks (or 2X more if you’re raising children). We pay our taxes… our electricity bills… we even pay for the internet that we’re sure our neighbors are somehow stealing. Surely we work as hard as those lounging around on their private jets and yachts, if not harder!

Still, the median 55- to 64-year-old American has only $89,700 stashed away for retirement, according to Vanguard’s most recent How America Saves 2022 report. Among those younger than 25, that figure is barely $2,000. (Once you include student loans, that figure drops to around negative $23,704).

There’s a Meme Stocks Investor in All of Us

And that’s why investors — both young and old — have turned to the riskiest stocks, cryptocurrencies and NFTs to catch up. In 2020, stimulus checks likely spurred the creation of meme stocks, according to several academic working papers. And even I would jump on the bandwagon, admitting that investors could have some fun buying Dogecoin (DOGE-USD).

“Even if it doesn’t make you a millionaire, it’s going to be far more fun than sitting on the sidelines,” I wrote. (In my defense, prices of the meme coin did rise over threefold over the next several months).

These speculative investments — much like Beanie Baby collections, horse racing and trips to Las Vegas — are meant to be enjoyable. Millions of Americans continue to play the lottery, despite it having a negative expected return. And it’s why companies like Robinhood (NASDAQ:HOOD) made every effort to gamify stock trading. Only by adding in a fun factor can investors justify this risk-seeking behavior.

Three behavioral finance theories magnify this effect.

The first is prospect theory, “the behavior of people who accept lottery-like odds when they are below their levels of aspiration.” That’s because people tend to make financial decisions based on a relative reference point (i.e., current wealth) rather than their absolute position. It’s why people from lower socioeconomic classes tend to play the lottery more often and also explains how the better-off can still find themselves wagering money on longshot bets.

The second is narrative fallacy, the willingness to become “drawn towards a less desirable outcome simply because it has a better story.” Dogecoin — with its identifiable mascot, meme community, and promises to “go to the moon” — remains worth over $10 billion despite having virtually identical architecture to rival Litecoin (LTC-USD).

The final is representativeness heuristic bias, or when the “similarity of objects or events confuses people’s thinking regarding the probability of an outcome.” It’s why the rise of one meme stock like GameStop (NYSE:GME) tends to spur interest in similar mall retailers like Bed Bath & Beyond. And it’s also behind our fixation over visionaries wearing black turtlenecks. It turns out that even Henry Kissinger and media mogul Rupert Murdoch aren’t immune, either.

In other words, the chase for meme riches isn’t a young person’s game. Nor is it one reserved for the desperate. As office lottery pools and the stock market both show, there’s a meme investor in all of us.

And the Costs…

But much like a gambling addiction, many investors can still take things too far. Reddit’s r/WallStreetBets — a subreddit dedicated to showcasing these outsized bets — is filled with screenshots of investors losing thousands (or hundreds of thousands) of dollars. And my own recent article “Mullen Is the New Dogecoin… Without Any of the Fun” was met with the exact scorn you would expect from ill-humored investors. (See, I told you so!)

One reason is the proliferation of options trading. Since 2018, the Chicago Board Options Exchange (CBOE) has seen the volume of Invesco QQQ Trust (NASDAQ:QQQ) options more than double. And among meme stocks such as GameStop, the figure is even higher.

Graph of QQQ options on the CBOE exchange

Another is the broad acceptance of buying low-quality companies. My own analysis shows the value of firms like Bed Bath & Beyond is worth precisely zero once you account for its bankruptcy risk. But try telling that to any BBBY fan and you’ll be met with even more derision than a hippie at a heavy metal concert. Social media echo chambers — and their glorification of losses — have turned speculative investing on its head.

In two short years, that’s turned meme investing from a freewheeling group focused on community and silly bets to one driven primarily by cold, hard profits. The Dogecoins of the world have degenerated into Mullens and Meta Materials.

Can Meme Stocks Make Us Better Investors?

Not every viral stock is automatically a loser. Tesla (NASDAQ:TSLA) used its inflated share price to raise billions for its Gigafactories — creating a self-fulfilling prophecy of growth. And AMC Entertainment (NYSE:AMC) CEO Adam Aron masterfully rallied the “ape” community to raise capital, pay down debt and stave off bankruptcy.

It’s a process investor George Soros has termed “reflexivity.” If enough investors believe something will happen, it often comes true in a self-fulfilling prophecy.

Most importantly, meme stocks are a crash course on strategic sophistication. A recent study by the New York Federal Reserve found that successful traders are typically hypersensitive to what others are thinking. And just as successful traders can be trained, so too can meme investors. Short positions can get covered the moment chatter of a short squeeze emerges. Stop-loss orders entered for peaking stocks. And consistent “buy” triggers set to monitor for unusual trading volumes. These strategies (among many others) employed by major hedge funds are now routinely replicated by individual investors trading less liquid stocks.

Buy-and-hold investors, of course, will do well to avoid the hype. Poorly run companies are still investment risks, no matter how popular their stocks become. But anyone who’s ever thought of making a quick buck will know that there’s a meme investor in all of us.

Tom Yeung is a market analyst and portfolio manager of the Omnia Portfolio, the highest-tier subscription at InvestorPlace. He is the former editor of Tom Yeung’s Profit & Protection, a free e-letter about investing to profit in good times and protecting gains during the bad.

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