Bulletin
Investor Alert

Lawrence A. Cunningham's Quality Investing Archives | Email alerts

June 19, 2021, 9:31 a.m. EDT

Why a crash in meme stocks AMC and GameStop looks more likely now

new
Watchlist Relevance
LEARN MORE

Want to see how this story relates to your watchlist?

Just add items to create a watchlist now:

  • X
    GameStop Corp. Cl A (GME)
  • X
    AMC Entertainment Holdings Inc. Cl A (AMC)

or Cancel Already have a watchlist? Log In

By Lawrence A. Cunningham

Could insider sales of meme stocks signal a coming crash in their share price? The empirical research suggests the answer is yes.

The substantial stock sales by directors of GameStop /zigman2/quotes/203755179/composite GME -3.90% and AMC Entertainment Holdings /zigman2/quotes/200235402/composite AMC -11.16% didn’t surprise most rational investors. It’s clear that the current prices of these and other meme stocks are vastly inflated. In fact, investors should have seen AMC’s issuing new shares at its bloated price to raise capital as a warning sign. 

Critics might lambaste the opportunism of such insider selling, citing  corporate governance gurus  encouraging director ownership to align interests with public shareholders. But who can blame them? What is surprising is that more outside shareholders haven’t taken the signal to sell.  It’s common for savvy investors to scan insider purchases and sales for signs of good or bad news ahead. Aggregate insider trading levels presage total stock returns for up to two years, according to the research of University of Michigan finance professor Nejat Seyhun, author of  Investment Intelligence from Insider Trading .

That said, some insider trades contain no signal at all, as directors buy when required to maintain mandatory ownership levels and sell when they need cash or to diversify investments. Moreover, insiders face reputational and legal risks when trading, so are careful not to signal hoarding good or bad news, lest they veer into unethical or illegal insider trading.

But these meme-stock cases seem clearer. At AMC, for instance, many directors all sold around the same time in large numbers, near the company’s recent stock offering.  Research by Durham University accounting professor Guanming He  and colleagues indicates that the presence of concentrated insider stock-selling is associated with an increase in stock-price crash risk. That stands to reason: insiders know more than outsiders, whether investors, strategists or economists.   

Of course, no one can discern the fickle features of markets that precipitate reversals. But He’s research  supports the view that insiders’ anticipation of future stock-price crash risk — from whatever source — does lead them to trim their holdings. In particular, the evidence is that insider sales are associated with 15-month-ahead crash risk.

 Such research may be particularly meaningful in the bizarre context of meme stocks. Compared to conventional stock trading, insiders are poised to make greater profits trading meme stocks and their trades are more informative given the greater degree of noise trading by uninformed traders.

Research on past outcomes is no guarantee of future results, but together with common sense and an appreciation that all bubbles eventually burst, I’d be willing to place my own bets. The 15-month time frame would put the bursting of the GameStop bubble in the first quarter of 2022 and AMC around the third quarter. I’d certainly take both bets before I bought either stock. 

Lawrence A. Cunningham is a professor at George Washington University, founder of the Quality Shareholders Group, and publisher, since 1997, of The Essays of Warren Buffett: Lessons for Corporate America. For updates on his research about quality shareholders, sign up here.

More: AMC’s bonds are benefiting from its meme-stock revival. That could be bad news for shareholders

Also read: It’s meme stock Whac-A-Mole as retail crowd shifts from Petco to pickles to electric cars in two days

/zigman2/quotes/203755179/composite
US : U.S.: NYSE
$ 146.80
-5.95 -3.90%
Volume: 2.39M
Aug. 4, 2021 4:00p
P/E Ratio
N/A
Dividend Yield
0.00%
Market Cap
$11.73 billion
Rev. per Employee
$424,150
loading...
/zigman2/quotes/200235402/composite
US : U.S.: NYSE
$ 29.84
-3.75 -11.16%
Volume: 85.50M
Aug. 4, 2021 4:00p
P/E Ratio
N/A
Dividend Yield
0.00%
Market Cap
$17.24 billion
Rev. per Employee
$43,642
loading...

This Story has 0 Comments
Be the first to comment
More News In
Investing

Story Conversation

Commenting FAQs »

Partner Center

Link to MarketWatch's Slice.