George Soros and GameStop

Regular HX Research readers are familiar with one of the most essential concepts in this newsletter...

We are buying stocks, not companies.

When you buy a share of stock, you own an economic stake in a business. This means that the stake technically gives you the legal right to the cash flows of that business.

But that doesn't mean a whole lot.

Most companies don't pay out that cash flow, and even if they do—via dividends—it's only a small amount.

In fact, some of the best stocks (and companies) of all time have never paid investors a dime of their cash flow. Just look at e-commerce titan Amazon.com, Inc. (NASDAQ: AMZN) and Warren Buffett's Berkshire Hathaway Inc CLASS B (NYSE: BRK-B).

Unlike a bond (where there are actual cash flows), stocks are valued based on opinions. At any given point, you can have more or less the same business trade at dramatically different values.

The only difference is that investors' perception of value may differ for several reasons.

Frankly, those reasons don't matter, only that you can identify them.

The famous phrase "perception is reality" is often accurate regarding stocks. Legendary investor George Soros illustrates one of the best concepts of this.

Soros adapted a sociology term—"reflexivity"—and applied it to economics and the markets. Reflexivity refers to the idea of a feedback loop: Investors' perceptions can affect economic fundamentals, which in turn can change investor perceptions.

Let's use a bank as an example. Banks take deposits from customers and then make loans equal to a multiple (five to ten times) of those deposits. Those loans will pay out over many years. If all the depositors don't come and ask for their money back at once, it's no problem.

If depositors become concerned about the bank's viability, though, they may rush to withdraw their money. The more people who withdraw their money, the more people become concerned, and the next thing you know, there's a "run on the bank," and the whole structure collapses.

Reflexivity is a powerful concept. Soros notes that if you can identify where something like this is about to happen, you've found a massive moneymaking opportunity.

Here at HX Research, we have frequently discussed the effect of human psychology and biology on financial markets, and these reflexive situations contribute to this.

Human beings are inherently emotional. They become excited (greedy) and panicked (fearful). Identifying where those emotions are about to flare up can be a great way to identify winning investment opportunities.

These concepts are always applicable to the stock market, but they are sometimes more useful than they were at other times.

Recently, we saw Soros's concept of "reflexivity" play out in one of the most unlikely places—the meme stock GameStop Corporation (NYSE: GME).

We are sure you are aware of what happened last month, but in mid-May, we saw the re-emergence of the meme stock influencer known as "The Roaring Kitty.”  He is a real-life investor named Keith Gill, but we are going to refer to him as "RK" for short.

On Sunday, May 12, he posted to X/Twitter for the first time in almost three years. He posted this image…

It appears to be someone holding a game controller and leaning in. We are not sure exactly what it was supposed to mean, but the stock market – and the meme stock army – read it as the return of RK to the action.

This sent the stock of GME flying. Here is the chart from early May until today…

You can see that the dormant stock price quickly exploded, from a little more than $10 per share to almost $50 per share within just a couple of days.

In the ensuing few weeks, RK made many more cryptic posts. Eventually, though, he confirmed that he had returned to an active role in GME stock and disclosed his position.

He even hosted a (somewhat painful to watch) live event where he took viewer questions and rambled on.

Anyone with a traditional stock market view might think the world had gone crazy as the stock repeatedly rallied on this social media train wreck.

Funny enough, we don't think Soros would think the stock market had gone crazy.

Soros fundamentally understands our view about stocks. When you buy (or TRADE) a stock, you are not buying the company—at least in the short term.

Any number of factors can drive buyers' enthusiasm, including the return of a social media personality like RK.

What we find most interesting about the GME situation is that it is a notable example of Soros’ concept of reflexivity. The idea is that people's perceptions of the future can influence the future.

First, the excitement about RK's return to the situation drove an investor frenzy. This drove the stock up towards $50 twice, and it is now (still) trading close to $25 per share.

This may not persist, but investor perception has created a momentary reality.

Second—and this is much more interesting to us—the investor perception has undoubtedly changed the company's prospects!

How might you ask?

The company recognized an opportunity and issued new shares to raise capital. We wrote about this on June 13.

The company issued an additional 120 million shares, raising them over $3 billion.

As we detailed in our note at the time, the company was already sitting on $1 billion of net cash and was burning around—$200 million per year. Thus, it was in a fine position to invest and reposition the business.

Now, however, after raising the additional $3 billion, they have a massive war chest! Their net cash is almost $10 per share.

What will they do with it? We don’t know. Will they produce positive value from it? We also don’t know.

What we do know, though, is that Soros' concept of reflexivity in the markets presented itself here and fundamentally changed the company's future prospects. Investor perception CAN change the future…