What makes a meme stock? Online enthusiasm for a beaten down company with doubtful prospects

Key Points

• Meme stocks are shares of companies with poor financial prospects that suddenly gain popularity through online enthusiasm, often leading to significant price increases despite weak fundamentals.
• Characteristics of meme stocks include poor growth prospects, such as outdated business models and intense competition, which can affect companies like GameStop and Kohl's.
• These stocks typically have a beaten down share price, drawing investors looking for a quick profit; examples include AMC Entertainment and Krispy Kreme.
• The price volatility of meme stocks can be significant, with rapid gains followed by steep losses, as seen with Opendoor Technologies.

NEW YORK (AP) — Investors occasionally scoop up shares of companies whose financial prospects appear dim. The consensus around such companies is that the shares should, if anything, fall further. But they suddenly get touted in online forums and take off for no fundamental reason. Wall Street has dubbed them “meme stocks.”

Here are some characteristics of meme stocks:

Poor growth prospects

Meme stock investors typically look for companies with poor financials that are unlikely to grow much in coming years. This could be due to a number of factors, such as an outdated business model or fierce competition.

Examples: GameStop, the original meme stock, faced a changing gaming environment where online gaming essentially replaced the need for video-game rental stores. Kohl's, battered for years by growth of online shopping, is now facing an increasingly competitive retail market that includes traditional department stores like Macy's and big-box retailers like Walmart.

Beaten down share price

Meme stocks are cheap. That's often part of the big attraction for investors looking to turn a quick profit. The low price allows for easier entry.

Examples: Krispy Kreme, known for its light and airy doughnuts, landed on Wall Street in 2021 at more than $19 per share. It sank below $3 last month. AMC Entertainment is a more extreme example. It was an $11 stock before the 2021 meme stock craze pushed it above $300. It's now trading at about $3 per share.

Big bets on the price dropping further

Big interest from short sellers often precedes a beaten down stock's transformation into a meme.

Short sellers are essentially betting against the stock in an effort to turn a profit. They do this by borrowing shares from a broker, then selling those shares. When the price drops, they buy back the shares at the lower price, give the shares back to the broker and pocket the profit.

Part of a meme stock's identity involves investors suddenly buying highly shorted stocks, which drives the price up. That forces short sellers to also start buying the stock to cover their losses, which is called a “short squeeze”. That drives the stock price even higher and results in a meme stock rally that benefits the investors who bought shares at their low point.

Hype

Online buzz is usually the key source powering a meme stock and not any change in the company's fundamentals. The hype typically comes from forums and platforms such as Reddit or YouTube.

Example: GameStop's entry to meme status started from a keyboard. Investor Keith Gill, better known as “Roaring Kitty,” rallied other investors to join him in buying up thousands of GameStop shares, changing the trajectory of the stock.

Volatility

Investing in meme stocks takes nerve. Gains can evaporate as quickly as they came.

Example: Opendoor Technologies. The beaten down online real estate company’s stock was trading below $1 per share through early July, then surged to as much $3.21 in the middle of the month as hedge fund manager Eric Jackson touted the stock on X. The stock is still trading just above $2, but that means buyers at the height of its rally ultimately suffered a loss.