GameStop shares: is this the start of another rocket higher?

With GameStop shares climbing 10% higher so far this week, Jonathan Smith asks whether a buying frenzy is about to kick off again.

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Volatility is nothing new for those who keep an eye on GameStop (NYSE:GME) shares. Having owned the shares myself for a period earlier this year, the volatility can present opportunities as well as risks. Over the past month or so, things settled down. Yet over the past week, the share price is up over 10%, and again, the internet chat rooms are popping.

The story so far

GameStop shares have previously seen large moves higher. The largest one was the first short-selling-sparked rally back in January. This was the move that really caught investors’ attention for the first time.

Back in January, the share price moved from circa $20 to over $350 in three weeks. Since the company itself hadn’t reported any fundamental change in business outlook or results, the reason for the rally wasn’t internal. After the fact, it became apparent that the level of short interest on the stock had been very high.

This means that large investors were selling the stock short, essentially borrowing shares and selling them. If GameStop shares fell in value, they would buy them back at the lower price and return the shares to the lender. In this way, investors could profit from a falling share price.

The problem with this is that if the share price rises instead, then there is a ripple effect through the market. Everyone is forced to buy back their shares, which actually forces the price even higher still. For the first rally in GameStop shares, this squeeze further fuelled the rocket.

Another factor that drove this price higher was a surge in retail traders buying the stock. Banding together on internet forums, the collective buying forced larger institutional investors that were short to close out positions.

Do GameStop shares have potential?

Since the first rally, there have been several other sharp moves higher (and lower) in GameStop shares. In all cases, the rally hasn’t been as large as the first one. This is logical, as many of the investors that were short have now closed out their positions. This means the price should be less prone to erratic moves.

After trading around the $150 mark for much of the past month, the shares moved up to $186 on Tuesday. They now trade lower, but are still up over 10% in a week. Many retail investors are still targeting a price level of $1,000. 

In my opinion, GameStop shares will struggle to continue to rally higher due to the detachment from their fair value. Back in March, the company released the 2020 results. It was a negative story when all was considered. 

Net sales dropped from $6.46bn in 2019 to $5.09bn. Gross profit margin fell by 4.8% to 24.7%, and comparable store sales were down 9.5%. Even with a boost in online sales, it wasn’t enough to prevent GameStop from registering a heavy loss.

From that angle, I don’t see how GameStop shares can sustain a rally in the long term. The outlook for the business isn’t improving. 

The risk to my view is that financial markets don’t function perfectly. Speculative buying and selling can distort a share price for longer than you might think. If enough people pile back into GameStop shares, then it could keep going higher. Yet ultimately this isn’t investing. In my opinion, it’s closer to gambling. Hence, I won’t buy.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

jonathansmith1 has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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