Can you make money going against the WallStreetBets crowd?
Yes, but you can also lose a lot – and fast.
Investors and traders who frequent the WallStreetBets forum, part of the website Reddit, have rammed up stocks with questionable fundamentals such as GameStop Corp. (GME, Financial) and AMC Entertainment Holdings Inc. (AMC, Financial).
They take glee in tormenting short sellers, who bet on certain stocks to decline. If they can cause the short sellers sufficient pain, the shorts must buy shares to undo their negative bets, which pushes the stock up even further.
This maneuver is a classic short squeeze, the kind Ray Dirks used to orchestrate decades ago. But Dirks didn't have the internet. Roaring Kitty and his fellow traders on WallStreetBets do. They can squeeze the shorts quicker and harder.
Short anatomy
Short sellers borrow shares and immediately sell them, hoping the price will fall. Eventually, they must buy shares to replace the shares that were borrowed, which is called "covering." If the price falls before they cover, they profit. They have bought low and sold high, only in reverse order.
Suppose your neighbor, Lucky, shorted 100 shares of GameStop on Jan. 29 at $360 a share. He covered on Feb. 17 at $50 a share. His profit was $310 a share, or $31,000, in two and a half weeks.
Easy money? Not really, because trades like these involve tremendous risk.
Suppose you were jealous of Lucky's success and decided to short GameStop the day after he covered. You shorted 500 shares at $44, receiving $22,000 in proceeds.
The stock meandered for about a week, then on Feb. 25 shot up to $184.68 intraday. Panicked, you covered at $170. Now you have a $63,000 loss. Financial ruin in seven days.
Here are my recommendations on three stocks that are especially popular with the denizens of Wall Street Bets. Be sure to read the cautions that follow.
GameStop
GameStop's business model -- selling video games and video game equipment in stores -- appears broken, as it witnessed three major loss years in a row.
Optimists say that Ryan Cohen, former CEO of the pet supply company Chewy (CHWY, Financial), will be GameStop's savior. Cohen owns a big chunk of GameStop's shares and is pushing it towards an online-selling model.
Suppose Cohen works a miracle and GameStop matches its best year ever, 2016. That year, profits were $3.78 a share. Apply a generous multiple of 20, and you get a stock price around $76.
Bear in mind, the stock traded between $4 and $5 for most of 2020 before the Wall Street Bets crowd pushed it to the moon. I would short the stock at any price above $76, but be prepared to cover it quickly if necessary.
AMC
AMC is the world's biggest movie theater chain and perhaps -- just perhaps -- crowds will return to the movies when the pandemic is over. But AMC's troubles precede the pandemic: It lost money in three of the past four years.
The stock was peacefully vacillating between $2 and $5 for most of 2020 before the Wall Street Bets crowd got hold of it and pushed it briefly (very briefly) to $20. At this writing, it's at about $8.
I would sell it short at $12 or more.
Tesla
Tesla (TSLA, Financial) is doing a lot better than GameStop or AMC, and it was a fad stock before WallStreetBets became famous (or infamous). The online forum has given its engine an afterburner.
In the coronavirus bear market last March, Tesla shares fell to about $72. Today, just under a year later, they stand at $675, which is 1,079 times recent earnings and 163 times the earnings analysts expect in the next year.
No question that CEO Elon Musk is an exciting, innovative guy. But that valuation in my judgment is unsustainable. At today's prices, only eight of 23 analysts call Tesla a "buy."
I think it's a good short at any price above $500.
Cautions
Beginning investors should never sell short. Experienced investors should do it with caution.
The maximum gain on a short sale is the amount of your initial proceeds (if the company goes bankrupt). The maximum loss is unlimited.
Sizing your short positions is crucial. I typically size a short position at 2% of the portfolio. With these faddish and volatile stocks, I might start at 1%. That way, if they go against you and double, you would still be at a reasonable portfolio weight.
If your normal short position is 4%, I'd start these at 2%.
Bear in mind that if lots of people are shorting the same stock, you may have to pay your broker a fee, or premium, for borrowing the shares. My rule of thumb is never to pay a premium of more than 3%.
Disclosure: I currently have no positions, long or short, in the stocks discussed today, either for myself or for clients.
John Dorfman is chairman of Dorfman Value Investments LLC in Boston, and a syndicated columnist. His firm or clients may own or trade securities discussed in this column. He can be reached at [email protected].
