As the effect of social media sentiment on the stock market grows, the ‘meme stock’ has flourished. We look at what makes a meme stock.
2020 has been an interesting year on Wall Street so far. We’ve seen record highs, the outbreak of a pandemic, the world’s second-largest economy get rocked, America’s largest exporter Boeing (NYSE: BA) post its worst sales in years, and two stocks — Virgin Galactic (NYSE: SPCE) and Tesla (NASDAQ: TSLA) — dominate the headlines by growing at breakneck speeds and gaining themselves the moniker of ‘meme stocks’.
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What is a meme stock?
Whether you pronounce it ‘meem’, ‘mehm’ or, god forbid, ‘me-me’, as social media has grown in importance in modern life, the ubiquitousness of memes has grown with it. So much so, it has even pervaded the stock market. Meme stocks have become a buzzword in certain investing circles over recent years and the accompanying hype has resulted in significant shifts in valuations.
A meme stock isn’t as easily defined as a growth or value stock, so to give it a definitive categorization would be inappropriate. Nor would actually categorizing it alongside growth and value stocks. They won’t be found in textbooks anytime soon, but to overlook their impact could potentially be an expensive oversight.
Some of the common characteristics meme stocks share are they’re usually overpriced and experience spikes of rapid growth in short spaces of time. Popular amongst millennials, they are prone to high volatility with valuations based around potential rather than financials. The sentiment around the stock is usually positioned around the future problem it solves, with talk of valuations very low down the list and usually only proposed by bears. FOMO is a big motivator to buy, while panic-selling at the slightest headwind is common, adding to the stock’s volatility.
A peek at marijuana companies like Tilray’s (NASDAQ: TLRY) and Canopy Growth’s (TSE: WEED) long term charts show a timeline of such stocks which are governed by hype rather than logic.
How did they start?
There are two main contributing factors that have led to the birth of the meme stock: commission-free trading and online investing communities. Initiated by companies like Robinhood, before being undertaken by some of the more established names like Charles Schwab (NYSE: SCHW) and TD Ameritrade (NASDAQ: AMTD), commission-free trading has opened up the stock market to the public, facilitating trading at any level. Both companies have seen a 30% plus increase in daily active revenue trades since they cut commissions. The added volume of trading amongst small retail investors has led to the hype and subsequent meteoric rise of fan favorites such as Virgin Galactic, Tesla, and Advanced Micro Devices (NASDAQ: AMD).
Online investing communities found on social media sites Reddit and Stocktwits are also a big factor in the birth of the meme stock. Stocktwits, a social media site much like a version of Twitter (NYSE: TWTR) dedicated solely to stocks, has over 2 million members, while subreddits r/stocks and r/investing boast over 500,000 and 900,000 members respectively. These numbers, along with the 897,000 self-proclaimed degenerates which make up the now-infamous ‘r/wallstreetbets’ subreddit, hold some significant clout in molding market sentiment. “$SPCE calls to the moon” is the current call-to-arms pervading the nearly-million strong online community.
Should you buy meme stocks?
The truth is, a meme stock isn’t to be treated like a pariah. Just because hype surrounds a company doesn’t mean its operations are affected. Whether it is in a future-relevant industry, has a visionary CEO, or is at the forefront of a megatrend that is about to sweep the globe, there is a reason that these companies get so much attention. What is affected, however, is its stock price. Anyone buying into these stocks is going to have to pay a premium, and they must be prepared for a lot more volatility. The trick is being able to identify the difference between deserved hype and hot air.
MyWallSt operates a full disclosure policy. MyWallSt staff currently holds positions in Virgin Galactic, Tesla and Twitter. Read our full disclosure policy here.