What Are Meme Stocks?

Meme stocks have been all the rage among retail investors during the COVID-19 pandemic. Meme stocks are created when a company's shares catch fire with individual investors on social media platforms such as Reddit and quickly skyrocket in price. But, as many traditional investors and analysts point out, these viral stocks can be very risky since they rely on high interest from small investors to sustain the stock prices' liftoff "to the moon."

However, simply writing off all meme stocks as too risky can be a mistake. For the right person, investing in the right meme stock for the right reasons can make a lot of sense.

What are meme stocks, and are they worth the investment?

Meme stocks are a battleground. More traditional investors decry the lack of business fundamentals and strong performance to justify sharp surges in stock price. On the other hand, as individual investors point out, given enough support from the masses, a climbing stock price (regardless of current fundamentals) can eventually equate to a stronger business. This comes from renewed consumer interest, along with a rebounding share price or the raising of fresh cash through capital markets when the stock price rises.

Image source: Getty Images.

What exactly are meme stocks?

Simply put, meme stocks skyrocket in price in a short period (often hours or days) because of a sudden surge in interest online or on social media and subsequent buying among small individual investors. These short-term surges can often reverse course just as quickly, though, making meme stocks far more volatile than average stock market moves.

The word "meme," from the ancient Greek word "mimema" — meaning imitation — is used to describe information that is imitated and often spread via pop culture references on social media. Thus, a meme stock is a shared investing idea imitated by other investors.

Top meme stocks right now

Now in year two of the movement, new meme stocks are being created all the time as individual investors look for new ways to beat the stock market. Here are five to do some more digging on (beyond arguably the two most famous meme stocks — video game retailer GameStop (NYSE:GME) and the world's largest movie theater chain AMC (NYSE:AMC)).

Market cap as of Sept. 8, 2021. Data source: YCharts. 

1. Bed Bath & Beyond

Bed Bath & Beyond has seen better days. Already struggling in the 2010s as the e-commerce onslaught slowly diminished sales, the company was hit hard by the pandemic and ensuing lockdowns. But Bed Bath & Beyond is making a rebound as the economy normalizes and is building a new omnichannel business  in stores and on the internet.

2. Blackberry

This Canadian company is known for pioneering the smartphone, but it quickly went by the wayside when Apple (NASDAQ:AAPL) revolutionized the space. These days, Blackberry is a software firm providing endpoint security and other Internet of Things management products for customers such as the auto industry.

3. Nokia

Nokia is another champion from the late 1990s and 2000s when the mobility movement was just getting underway. But Nokia has transitioned from consumer products such as cellphones and refocused its attention on infrastructure equipment for telecom and mobile network operators. With 5G mobile network construction now taking place in earnest, Nokia could rekindle some sustainable growth.

4. Palantir

A member of the hot 2020 IPO stock class, Palantir quickly gained a large investor following after making its public debut. The company builds enterprise big data and AI software that helps organizations update their operations for a digital era. Palantir has concentrated exposure working for government entities, but it is quickly working to expand further into the private sector.

5. Virgin Galactic

Virgin Galactic was the first SPAC deal struck by former Facebook (NASDAQ:FB) executive Chamath Palihapitiya. The company, founded by Richard Branson, is part of a new billionaire-backed space race with Jeff Bezos' Blue Origin and Elon Musk's SpaceX. Virgin Galactic is conducting science research flights and is eyeing more general commercial "space tourism" voyages (for a hefty ticket price of $250,000 per seat) in the not-so-distant future.

What started the meme stock movement?

The meme stock movement unofficially started in the summer of 2020 when most people were stuck at home during the first few months of the pandemic. Looking for something to do and a way to turn some of that extra free time into money, many people turned to the stock market and social media for ideas.

Video game retailer GameStop is recognized as the first meme stock. RoaringKitty (aka, Keith Gill) started sharing his views about GameStop stock on Twitter (NYSE:TWTR), YouTube, and the subreddit r/wallstreetbets in 2019, explaining why a combination of high short interest from short sellers (firms that bet against a company) and an undervalued and underappreciated GameStop business could lead to huge gains. Add in a pandemic, a surge in new investors who grew up online, and the ease of stock trading on new apps such as Robinhood Markets (NASDAQ:HOOD), and all the right ingredients came together to create a viral meme stock movement.

Advantages of meme stocks

Because a surge in buying activity can send a stock price soaring, there are some benefits to owning meme stocks (and potential meme stocks before they rocket higher).

• A chance for very high returns in a short period.
• An ownership stake in a new investment idea before the rest of the market gets wind of it.
• A young generation raised on social media has decades of prime investing ahead of them, so the meme stock movement could be here to stay.

Disadvantages of meme stocks

As with other highly volatile investments (such as the related cryptocurrencies movement), there are drawbacks to betting on meme stocks.

• As with other moments of viral skyrocketing stock prices, the meme stock trend may not last forever — especially as some traders return to work and spend more time away from home.
• Short-term stock prices are driven by supply and demand, so price moves are unpredictable and can lead to quick losses.
• Some meme stocks don't trade on any fundamentals, and returns can suddenly reverse course, causing the company to lose its luster among individual investors.

How to identify a good long-term meme stock

If you're an investor looking for a longer-term holding (years, rather than a stock to trade over the course of days, weeks, or months), there are some important factors to consider before buying a meme stock. Some business fundamentals and economic trends can go a long way toward balancing out what can be fleeting social media trends or hopes of a short-term short squeeze.

• A company with great fundamentals such as stable or growing revenue, healthy profit margins, and a solid balance sheet (e.g., more cash and equivalents than debt).
• Great fundamentals aren't required, but if a business is struggling, an actionable plan to improve its financial results over time can do a lot to help sustain stock price growth.
• If a company has suddenly reached meme stock status and management has yet to comment on what it will do with its newfound strength, a business benefiting from strong secular growth trends (such as technology) would be an added bonus.

Investing in meme stocks and ETFs

Even with meme stocks, the old adage, "Don't put all your eggs in one basket," still rings true. The good news is that meme stocks come from all nooks and crannies of the stock market, so it's possible to build a diversified portfolio of holdings that can catch a tailwind from various places.

If you're not interested in building and managing your own portfolio of meme stocks but still want some exposure to the movement, there are some ETF solutions to help. One example is the VanEck Social Sentiment ETF (NYSEMKT:BUZZ), an actively managed portfolio of 75 stocks that rank high in social media conversations. Top holdings in the portfolio include GameStop, AMC, and Palantir. This ETF has an annual expense ratio of 0.75% (meaning it costs $75 per year for every $1,000 invested). Other meme stock ETFs are on the way, too.

Meme stocks lure investors with the promise of potentially big returns in little time. However, for those seeking sustainable long-term gains (the way real multigenerational family wealth is built up), look to build a portfolio of multiple meme stocks that have more than just a one-off chance of providing returns. Bear in mind that meme stocks can be especially volatile, so plan accordingly and be prepared to continue investing more over time.