Keith Gill: Finding deep value in meme stocks

Keith Gill – who goes by the moniker DeepF***ingValue – bought Gamestop shares and options in Sep 2019 when the price was merely around $4 per share. He posted a screenshot of his trade on reddit. And he was called a retard.

Why would anyone buy shares of a dinosaur company? A company who sold video games through brick and mortar stores – in an era of netflix? Surely the company would go bankrupt soon – no?

But Gill proved people wrong with his insight and investment. At its height, the share prices of Gamestop had spiked over $480 per share!

Gill had converted his initial $53,000 into more than $48 million at the height of the craze! And Gamestop became the poster boy of meme stocks that took down many a hedge funds as they made huge losses betting against retail investors like Gill.

How did Keith Gill find this deep value stock? And can his strategy be replicated?

The moneyball system of investing

In 2002, Oakland Athletics – a baseball team – created a world record by winning 20 consecutive games. Michael Lewis studied underdog baseball teams and wrote a book on how they won. “Moneyball” was a bestseller.

The wondrous part is that Oakland Athletics were ranked in the bottom of the pack before the season began. They had lost some of their best players because other teams were willing to pay a lot more for them!

It was an unfair game. I mean, how could a team like the Oakland Athletics who spend $44 million on player salaries… compete against the New York Yankees who spend $125 million on player salaries?

And yet they set the world record for the highest streak of wins! How?

Their secret was they used analytics to find players with deep hidden value. Players that most scouts passed on, and most teams considered defective. Maybe because of their old age, or a weird arm action.

But Paul DePodesta along with Billy Beane – the general managers of the team – focused on analytics to find such unloved players. Players who could be bought for cheap – because no one else wanted them. And they built a team that could punch way above their weight – by searching for the least expensive player that met their stats!

Tampa Bay Rays vs Oakland Athletics

Oakland Athletics started using moneyball. But it was the Tampa Bay Rays that mastered it. While Oakland Athletics had the longest winning streak, they never made it past the playoffs. On the other hand, Tampa Bay Rays reached the finals of the World Series – and with a much lower spending budget!

What did the Tampa Bay Rays do that the Oakland Athletics and other teams didn’t? Let’s go back from baseball to investing. Tampa Bay Rays heeded to Warren Buffett’s advice:

“It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.” – Warren Buffett

Instead of going for the cheapest players of a particular skillset, Tampa Bay Rays started opting for players who could do a couple of things well and were undervalued. They still used analytics to find underloved players. But by opting for undervalued allrounders, Tampa Bay Rays could create better lineups against their competitors – based on who the competitors were. They could mix and match and play lego to create the best team for the day.

The key was to still find deep value using analytics. But to build a team that provided multiple ways to win.

Keith Gill and the Gamestop saga

Which is exactly what Keith Gill did.

Most people thought that Gamestop was a dying retail company. And it would go bankrupt soon. But Gill found value in it. Because even though Gamestop was a waning company, it would last for a few more years and everybody was overestimating how quickly it would die.

Gill realized that the company was deeply undervalued and its shares were oversold. Going through their balance sheet and their profits, the company should be worth around $12. And not $4.

But the hedge funds had been overzealous shorting a “sure” thing. And so the prices had tanked faster than the value of the company had.

But beyond value, Gill found an anomaly. The company was buying its stock back. And they were cutting their costs. They even sold their private jet.

Would the executives of a company cut costs and buy back shares if they didn’t have a plan to turn the company around? So Gill dug in deeper. And he found that the company had various options – any one of which could help get the price up to its fair value of above $12.

  • The company was pivoting to online sales.
  • The company was aggressively cutting costs, which would mean higher net profits
  • The company executives realized that the share price was selling below their true value. Hence they started buying back the shares, reducing their supply. The fewer the outstanding shares, the higher the earnings per share.
  • The company was actually doing a little bit of financial engineering by marking their inventory at a lower price. Which would allow them to continue buying back the shares at a discounted price for longer.
  • Hedge funds shorting the stock had not considered the lifecycle of the video game consoles. As new consoles would be released next year, sales would automatically go up.

There were just so many ways that Gamestop could turn its fortunes around – and if not thrive and start growing again, at least bring the price back up to its real value.

Fortunately for Gill, the price didn’t only go beyond his estimated $12 – it reached stratospheric levels of $480! And that’s because, being sure that the company would go bankrupt – the market had shorted 140% of the stock that the company had! When people had to pay back the stock they had shorted, the price squeezed up beyond imagination!

So how can you find deep value?

  1. It starts with collecting data. You need to have a good way of gathering data so that you can actually find things that are unloved by the market. And you have to know that when you invest in the unloved thing, people will doubt your judgement.
  1. But it does not end there. Because just chasing the unloved means you are simply finding undervalued things. To go from merely undervalued to deep value, further work is needed. You have to filter the unloved to see which of them have multiple opportunities to win.

Action Summary:

  • Deep value is finding underloved things that have multiple ways of winning.
  • Have conviction to invest in unloved things. Undervalued ideas will always seem unpopular for a very long time.