Market strategist explains the 3 hallmarks of meme stocks

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Meme stocks are making a resurgence as the broader stock market ends the first quarter on a strong note.

Though the meme stock frenzy hasn't quite reached the same intensity as it did in 2021, when GameStop (GME) and AMC (AMC) stocks catapulted to new heights, the meme phenomenon has continued in a concentrated handful of standouts.

In recent trading, for example, there’s been an uptick in interest in GameStop (GME) sparked in part by new additions to the market via IPO, such as Reddit (RDDT) and Trump Media & Technology Group Corp. (DJT).

Reddit stock soared over 90% to more than $65 a share in its first three days of trading, well above its IPO price of $34 a share. Shares of the social network platform have continued to experience volatility, however, falling to around $49 as of Thursday's close.

And after initially rising by as much as 50% on its first day of trading, Trump Media also saw a decrease in value later in the week, as the stock closed Thursday's session around $62 per share.

"It's been momentum all along since November, but the leading momentum stocks have generally been stocks that have been delivering the goods," Interactive Brokers chief strategist Steve Sosnick said on Yahoo Finance Live (video above) about the broader market rally. "We're starting to see people chase stocks just simply because they're going up, not because of any fundamental reason. That, to me, indicates froth."

Annex Wealth Management's Brian Jacobsen told Yahoo Finance Live that investor interest in meme stocks could be tied directly to FOMO mentality, or a fear of missing out.

“They’re trying to find the next hot thing, and they’re just beginning to chase it and pile into it,” Jacobsen said. “That obviously can work well, but it can also then end in tears, especially if you don’t get into those names early enough.”

3 hallmarks of meme stocks

But what is a meme stock, exactly?

Sosnick explained that there are three main criteria for evaluating if a stock belongs to the category.

The first indicator of a meme stock is a "quasi-religious fervor," according to Sosnick.

"It's one thing to be enthusiastic about a stock, it's another thing to just be so hyped up about it," Sosnick said. "Think about how the real apes were in AMC, the real devotees in GameStop early on. Certainly, one can say that about the former president's base, who I think helped getting DJT's stock moving."

The second criterion is a disregard for fundamentals. Traditionally, investors look for opportunities that offer a financial return over a long-term time horizon, especially one that can beat the market's performance over that same time period.

On the other hand, many meme stock investors have a much shorter time horizon in mind as they look to quickly flip speculative assets if the price spikes to turn a hefty profit.

"If you're believing in the faith of a stock, if you have a non-analytical view of the stock, well, then you could disregard the fundamentals," Sosnick added, noting that stocks trading on momentum can seem expensive "by any conventional metrics."

NEW YORK, NEW YORK - MARCH 21: The trading floor of the New York Stock Exchange (NYSE) prepares for Reddit's initial public offering (IPO) on March 21, 2024 in New York City. The social media platform Reddit priced its IPO in the range of $31 to $34 per share on Wednesday. Reddit has raised  $748 million and its IPO share price will be determined later in the trading day.  (Photo by Spencer Platt/Getty Images)
The trading floor of the New York Stock Exchange (NYSE) prepares for Reddit's initial public offering on March 21, 2024, in New York City. (Spencer Platt/Getty Images) (Spencer Platt via Getty Images)

Lastly, Sosnick said investors should watch for high short interest.

Short interest refers to bets made by investors that a stock's price will fall rather than rise. In the case of DJT, the high short interest was precedented but still in a high range of 11%. The average short interest for public companies is typically between 3% and 4% but can reach as high as 40% when investors are more pessimistic.

Essentially, according to Sosnick’s definition, meme stocks utilize an intense passion from retail investors who are willing to take on more risk and ignore some of the more conventional investing strategies for a chance at higher returns, especially in the short term.

Public COO Stephen Sikes largely agreed, though he doesn’t think it’s quite that simple. Sikes claimed that meme stocks are attractive to a wide variety of investors with different goals and strategies, not just those looking to flip them for an immediate return.

“We have some investors that are long-term buy-and-hold investors, and we have some that are traders trying to take advantage of volatility and momentum in the market,” Sikes said. “They see an opportunity here more so than sort of the quasi-religious fervor you might have seen in prior eras.”

As for why meme stocks are back in the picture, Sikes told Yahoo Finance that a combination of investors’ familiarity with a company’s products or brand and increased market volatility is likely to blame.

And when asked where investors may be able to find the next targets of “meme mania,” Jacobsen noted the market may shift toward the small-cap space and underperforming sectors such as industrials, manufacturing, and utilities.

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