Earning Incredible Returns During The Era of Meme Stocks


With meme-stocks constantly in the news these days, the investing media spends a lot of time (perhaps too much) talking what meme stocks are doing on any given day.

“Gamestop shoots up 20% today!”  “Investors retreat, as BBY crashes by 25%!”  “AMC spikes 100% in a single day!”

Every day it’s the same nonsensical reporting about the stock price of each touted meme stock.  As if the stock price contained some kind of valuable information.  Unfortunately, very little effort is spent on understanding the long-term outcomes of owning these investments.

That’s probably because most of these meme stocks are actually pretty dodgy businesses.  Businesses you wouldn’t want to own in 20 years.  As a result, investors in meme stocks are unlikely to hold for very long.  These investors are simply waiting to catch a big share spike, and then cash out.

THIS is the difference between a short-term speculator (a gambler) and a long-term investor.  Speculators are ultimately looking to sell that stock to another investor at a higher price (the Greater Fool Theory).  Meanwhile investors look to profit from the growing value of a company as it compounds over time.

Almost by definition, real investors must be long-term holders of assets due to the slow nature of compounding.

 

When Mr. Market Works Against You

It’s been said that the best way to earn money from the stock market is extreme patience.  In other words, holding stocks for the long term while they quietly compound for years and years.  It’s an old way to make money, but also a VERY GOOD way to make money.  Provided you’re patient enough.

Sure, speculators can make fast money doing a little gambling on these meme stocks… but they can lose money just as quickly.  The outcome is essentially random.  Just like rolling the dice in Las Vegas.

craps
A good way to think about investing in meme stocks, is like rolling the dice at a Vegas craps table. You could win big, but you could also lose.

Conversely, the beauty of being a long-term stock holder is that winning it isn’t random.  It’s just basic math.  Value will compound over time, and the stock price should (eventually) reflect that growing value.

Notice I said, “should”.

At times Mr. Market does not reflect the true value of a stock in its stock price.  The Market only does so in fits and starts.  There can be long periods (sometimes even decades) when stocks (or other investments) simply don’t “go up”.  Holding for the long-term can be a very difficult proposition when this happens.

Ask yourself — How long could you hold onto a stock (or fund, or ETF) that stayed flat for years?  Could you hold for at least one year?  That’s easy enough.  I think most people could manage at least a year without too much trouble.

How about 5 or 10 years?  It’s only at this point when I start to consider a holding period “long-term”.

It’s during these long “doldrum” periods, when human patience begins to fail.   Holding for the long term becomes a tricky proposition when your investments fail to rise year after year.  Most investors might be patient enough to last a year without earning a return, but how long before your eyes begin to wander?

Eventually, patience runs out.

 

Know When To Hold Em

Holding a stock can be a lot like trying to ride a bull.  The ride can be exceedingly wild — because the stock market can literally do any random thing during your holding period.

The trick, (of course) is not falling off that bull.  Ultimately, it’s the final destination that matters — not the journey of the stock between the time when you buy and when you sell.  Anything in-between those buy and sell points is simply noise created by the Market.

riding a bull
Holding stocks is a bit like riding a bull — They’ll gyrate wildly during your ride. The trick is to hold on through all those gyrations.

So how do we know to keep holding if Mr. Market doesn’t agree with our assessment?

Avail yourself to the fact that as long as the business is compounding value at good rates of return, you shall be rewarded.  (Eventually… it might take awhile.)

This is not a measure that can be found in the stock price however.  Investors must look much deeper than just the cover of the book.  They must pay great attention to other metrics — like earnings, free cash flow, book value, ROA, ROE, and returns on reinvested capital.

And then completely ignore the stock price.

(Note: A healthy growing stream of dividend is often associated with firms able to compound capital, but this is not always the case.  Many investors have been caught in value traps chasing a stream of dividends, so be forewarned!)

I like to regularly remind myself that as long as the business is compounding value, there should be no need to worry about what Mr. Market is doing.

 

And Know When To Fold Em

Eventually there does come a time when its finally time to part ways with an investment.  Many investors have trouble with this.  You wouldn’t believe how many times I’ve heard the lament, “I sold and then the stock went up!”

There’s a number of popular ideas about when to sell a stock.

If you’re a value investor, you might say, “I’ll sell when the stock exceeds it’s fair value.”  But this idea has problems.  You could make errors in your valuation of the stock.  The stock could also be temporarily overvalued (as good stocks often are).  As long as the business continues to improve, the overvalued stock could continue to rise (and continue being over-valued).  Netflix investors know this situation very well — The stock has been overvalued for as long as I can remember.

If you’re a growth investor, you might say, “I’ll sell when the stock’s growth slows.”  This idea also has problems.  Growth isn’t like a light switch ‘on’ or ‘off’.  Growth can ebb and change constantly.  A stock can also grow extremely slowly for decades.  I like to call these stocks “slow growth monsters“.

My personal theory about when to sell is much simpler — Sell when you need the money, or when the investment no longer compounds at desirable rates of return.  Simply put, when the investment is no longer “improving” at rates that seem desirable, it’s finally time to move on!

 

Final Thoughts

As long as your investment can be seen to be improving at good rates of return over time, there really should be no reason to sell.  Just stay put and keep holding.  Over time Mr. Market should reward you for your patience as value compounds.

Unfortunately blips do happen.  Black-swans come out of nowhere (like COVID-19) and screw things up royally.  Last year the world went topsy-turvey, and many businesses lost money.  Stock prices tanked (at least for awhile).  Does this mean investors should immediately sell?  No, of course not!  It makes sense to give your investments time to recover.  Usually it takes more than one year to right the ship after a terribly disruptive event.

I try to give my investments at least 3 years to turn things around before I make any big decisions about selling.

Try to view these blips not as problems, but as opportunities.  A chance to buy shares at a much lower price than the market would normally allow.  So far this has worked out splendidly for me during each of the last 3 recessions.  I took the opportunity to add to my existing positions at bargain rates.

Some of those investments went on to earn 1000%+ returns.  But extreme patience was required.  I suffered for years through negative returns and even dividend cuts … until I was eventually rewarded.

It just goes to show, real investing has very little to do with the stock price.

 

[Image Credit: Flickr1, Flickr2ThoroughlyReviewed]

19 thoughts on “Earning Incredible Returns During The Era of Meme Stocks

  • June 13, 2021 at 8:14 AM
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    Good stuff as always and a positive reminder to be patient, search for long term value, and stay the course. Thanks for the article!

    Reply
  • June 13, 2021 at 8:43 AM
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    I think many people misunderstand what most of the “investors” in the big meme stocks are thinking.

    They believe that there is massive manipulation of these stocks, and that hedge funds/market makers/high frequency traders are distorting the market to the detriment of these companies and retail investors. There is also a belief that the financial media is complicit in this market distortion. Throw in some shady no fee brokerages that sell order flow data and you have quite the conspiracy tale.
    It’s a deep rabbit hole of misinformation and confirmation bias if you go digging in those sub reddits.
    However, I expect when the dust settles, the redditors will be at least partially correct.
    I’ll stick with my boring ETF’s.

    Reply
  • June 13, 2021 at 1:24 PM
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    When I was young and just started investing, I just bought stocks that I liked… not the smartest way to buy for sure. I had some wins and some losses (GM), but I did buy 13 shares of Amazon stock at $67/share. Considering it’s over $3,300/share now, that’s not too shabby. It’s one of the few individual stocks I still hold onto (everything else is in index funds).

    Even though it’s a win, that’s a pretty big part of my portfolio and I don’t like that. Should Amazon start to fall off its throne (they all do eventually), that could really hurt my portfolio.

    So I decided to sell slowly to celebrate victories. I sold one share once it hit $2k and that basically pulled my initial investment off the table. Once it hit $3k, I sold two more shares. I’ll probably sell more if it hits $3,500 or even $4k.

    It’s not a perfect strategy because it could always go the other direction as well, but I already feel better since I’ve had a nice win on the shares I’ve already sold.

    Anyway, a long story, but if I was still young, I could imagine getting sucked into the hype of these stocks like Gamestop or AMC… the scent of “easy money” can be alluring when you don’t know what you’re doing. I like your strategy of buying right and then just holding.
    Jim @ Route to Retire recently posted…Giving Myself Permission To Breathe

    Reply
    • June 16, 2021 at 2:25 PM
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      You’ve done amazingly well on that Amazon stock Jim! I’m impressed!

      Reply
  • June 13, 2021 at 4:24 PM
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    I love to buy and hold. Crazily enough I bought American Airlines, AMC and Blackberry. I knew that WSB was planning on raising them and I just bought them at around $10 a share and decided to hold them. Now I don’t follow the news very often but my partner does. He told me AMC went way up. I probably won’t sell them unless the price gets really crazy. I’m not really even sure why I bought them in the first place, except for $10 a share I figured I could splurge $60 or so.

    Reply
  • June 14, 2021 at 2:54 AM
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    Way way back when I foolishly tried buying stocks in the 1990’s they announced that the second Star Wars trilogy would be made. A company called Galoob toys was poised to corner the market on the figurines etc. I figured it was a no brainer and bought some. Well, it wasn’t. I did make about $800 bucks in the end, but what looked too good to be true was nothing more than a meme as you put it.

    Index funds and no effort is much better 🙂

    Reply
    • June 16, 2021 at 2:27 PM
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      Indeed some of the simplest buy-and-hold strategies are best.

      Reply
  • June 14, 2021 at 8:02 AM
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    The meme stocks are okay if you’re a daytrader. You can react quickly and sell when it drops.
    For regular people, it’s way easier to buy quality companies and stick with them.
    One dividend blogger said he will never sell any stock. That makes life a ton easier.
    Just buy good dividend stocks and that’s it. He holds many positions so even if a few do badly, he’ll be fine. I like it!
    Joe recently posted…How I Choose Which Real Estate Project to Invest In

    Reply
    • June 16, 2021 at 2:28 PM
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      Sure, why not! Given long enough holding periods some will inevitably fail, but some will also succeed immeasurably!

      Reply
  • June 14, 2021 at 12:55 PM
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    Great post. I definitely prefer buy and hold strategy – substantially all of our portfolio is in “boring” low cost index funds. While we do have a few individual stocks, they’re mostly in companies we’ve researched and believe in.

    Anytime I’ve bought an individual stock in a speculative move it’s caused me more stress and headaches than the gains were worth (there were plenty of losses, too). I did end up with a bit of AMC, purchased near the low last year, but as soon as it became a meme stock I traded it. Made a great % profit, though small dollars because I’m risk adverse. The speculative investing rollercoaster is just not a ride I enjoy.
    Mrs. RFL @ RichFrugalLife recently posted…HEALTH IS WEALTH: WANT AN EXTRA $900K? TAKE A WALK

    Reply
    • June 16, 2021 at 2:28 PM
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      It certainly isn’t something I enjoy! I’ve tried that game, and it’s not for me!

      Reply
  • June 15, 2021 at 11:59 PM
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    I wish I had your patience and discipline. I recently bought some Corsair Gaming stocks because I saw people hyping it up on an internet message board. Hopefully it will go up and I can sell it later for a profit. I know I shouldn’t be doing this. Investing in profitable companies that “compound value” like you mentioned is the best way to produce long term wealth. But I just get very emotional sometimes and can’t help it, lol.
    Liquid recently posted…Bernard Arnault has become the richest person in the world

    Reply
    • June 16, 2021 at 2:30 PM
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      Such investments are mostly luck. My suggestion would be to avoid this kind of speculation and learn how value compounds in a stock for shareholders over time.

      Good luck!

      Reply
  • June 16, 2021 at 11:50 AM
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    I have to admit to dabbling in swing trading but one basic premise I try to adhere to before I buy, is at the end of the day do I mind holding this stock? If the answer is “no”, I won’t buy-in. I look at the financial statements, industry outlook, analysts’ opinions etc. before I buy and I try to buy on days when the market is off, and sell when it rallies.

    If you look at these Meme stocks underlying value and worth, it is just plain scary. Yes, quite a few people will make money on them but it really is a case of rolling the dice and more will lose. Thanks but no thanks, I’ll stick with my little stock plays with solid stock.

    Reply
    • June 16, 2021 at 2:32 PM
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      Indeed, the valuations around meme stocks make no sense. Furthermore, I doubt anyone could guarantee AMC or Gamestop will be around in 10 years. This makes any investment in these firms *highly* speculative.

      That’s not a game I’m interested in playing!

      Reply
  • June 18, 2021 at 11:39 AM
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    Hey
    Good post! It’s just amazing what happens at the stock market. I am long term oriented, I like growth tech stocks and my dividend positions. Over time, that works out great, but it’s of course a bit boring, unspectacular. Which I like.
    Cheers
    SavyFox recently posted…LVMH stock is an expensive diamond

    Reply

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