The new Pete Davidson and Seth Rogen film Dumb Money shows how investors helped the prices of meme stocks like GameStop skyrocket. How should long-term investors think about these “get rich quick” stories?
A good place to start is with prices themselves.
It’s not often that one stock price ends up central to a Hollywood blockbuster. But at the end of the day, price reflects the expected return demanded in aggregate by market participants to hold shares of a company. Equity markets process hundreds of billions of dollars’ worth of trades on an average day, so prices incorporate a potentially massive number of viewpoints on a company.
Investor preferences (like demand for “meme stocks” in 2021) also play a role. If market participants prefer one company over another, the rate of return demanded to hold that company’s stock may differ for that reason alone. This effect is analogous to color preferences of car buyers; if enough shoppers are averse to primary colors, you may be able to get a relative discount on that new, bright-yellow car!
Nearly a century of empirical data tells us that we can use market prices to systematically identify stocks with higher expected returns. This approach is indifferent to those specific considerations driving price differences.
What hasn’t generally benefited investors is attempting to outguess or outsmart markets.
Concentrating your investment on the GameStop or AMC of the day exposes you to unnecessary risk (Exhibit 1). To have the chance of striking it rich on one of these stocks, you must pick the right needle from the haystack before it goes up and sell before the drawdown.
Exhibit 1: The Harder They Fall
Drawdowns of meme stocks, March 2020–May 2022
Past performance is no guarantee of future results.
Even if you manage to land a big winner once or twice, our research has found that this luck is unlikely to repeat throughout a lifetime of investing.
The degree of difficulty in anticipating market movements more effectively than the millions of other participants who saw Dumb Money this weekend is such that investors’ time is probably better spent enjoying the laughs than trying to replicate the storyline.
READ MORE: How We Handled GameStop
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This material has been authored by Dimensional Funds and CLF makes no representation and takes no responsibility for the accuracy of the information presented. It is being used with permission and originally published by Dimensional Fund Advisors.