Two weeks ago, we emailed our clients to address the story of GameStop.  Figuring that others might appreciate our viewpoint, below is the entirety of that email.

To our clients,

With GameStop dominating the headlines this week, we wanted to quickly address the topic and discuss what, if anything, you should be doing about it.

For those who haven’t been following, GameStop (and a handful of other stocks) have recently soared in price, with the surge fueled mostly by young traders who, on Reddit and elsewhere, have organized in an attempt to punish hedge funds and other institutional investors who had shorted the stock of the video game store chain that they liked. A more detailed primer can be found here.

You might be asking yourself, “should I be participating in this?” Well, technically you are – the diversified stock funds you own include almost every publicly-traded company in the world, including GameStop. (That said, GameStop represents just ~0.03% of your US stock portfolio, so don’t go telling off your boss just yet…).

For those feeling like you might want to participate beyond that – either by buying the stock directly in the hopes that it continues to rise or by shorting it in advance of its nearly inevitable fall – you would be wise to ignore those temptations. This will almost certainly end badly for those who are buying GameStop under the assumption that “the world has changed forever, so I better get in.” As investment pioneer Benjamin Graham once said, “in the short run, the market is a voting machine, but in the long run, it is a weighing machine.” In other words, investor sentiment can drive short-term price changes, but business fundamentals win out in the long-run. Whenever the short-term voting ends and the long-term weighing resumes, GameStop stock will be worth whatever the company is actually worth – i.e., the best estimate of its discounted future earnings.

For those tempted to short GameStop stock, another quote comes to mind, this one from John Maynard Keynes: “the markets can remain irrational longer than you can remain solvent.” This is especially true when shorting a stock – a dangerous game where the potential losses are unlimited. Just ask those rational folks who shorted GameStop shortly after it started to spike last week.

To us, the more interesting discussion is what this story says about the efficiency of markets, which is a fundamental tenet of Geometric’s investment philosophy. A perfectly efficient market has always been a purely academic concept – nobody believes that it exists; not us, not even Professor Eugene Fama, who won the Nobel Prize for first hypothesizing that markets are efficient. But the practical application of this concept – the only thing that matters in the real world – is that whatever inefficiencies exist cannot be reliably exploited. This has been proven over and over again across the history of markets and is as true today as it has ever been.

There is no reliable way to exploit this GameStop irrationality, nor to predict and exploit the next time an inefficiency reveals itself. So, as usual, we’ll stick to our investment plan and allow the long-term weighing machine to do its thing.

All the best,
Andrew, Tom, & Patrick