How to Turn $27 Million into $110 Million in Just a Few Days

Photo by: Tony Webster from Minneapolis, Minnesota, U.S., CC BY 2.0 via Wikimedia Commons

Did you hear about Jake Freeman, the 20-year-old who parlayed a $27 million investment in Bed Bath and Beyond (BBBY) into $110 million?

The news generated a lot of pearl-clutching, and for good reason.

For one, a twenty-year-old slinging that much money around is unusual.

For another, this was the ONLY position in the fund.

Yet another, Freeman happened to top-tick BBBY perfectly. (Translation: he sold at the top, right before the stock rolled over and died.)

And to top it all off, he made all this dough in a meme stock.

A meme stock refers to the shares of a company that have gained a cult-like following online and through social media platforms. These online communities can go on to build hype around a stock through narratives and conversations elaborated in discussion threads on websites like Reddit and posts to followers on platforms like Twitter and Facebook.

Meme stock communities can thus greatly influence the prices of those shares through coordinated efforts to, for example, initiate short squeezes in heavily shorted names. As a result, meme stocks can become apparently overvalued relative to their fundamentals yet remain elevated for prolonged periods of time as members of the meme stock community keep their prices propped up.

– Investopedia

As a former stockpicker and portfolio manager, I feel the media coverage left a couple of critical questions unexplored. But in any case, even if all you do is invest in index fund ETFs, there are a few lessons to be gleaned from this story, so bear with me.

Weirder than having $27 million to invest, is his running for US president when he was 18, because “He wanted to be the youngest on the ballot” and his listing every single AP and SAT score, college and grad school GPA on his LinkedIn profile. But I digress.

You want to know my hot take on his trade, not his psyche.

Freeman grew up in Summit NJ, a town with all kinds of money – old, well-seasoned money, nouveau riche money, and pots of Wall Street money. He started investing when he was 13. In a life imitating art moment, I am compelled to share that his uncle Scott, a pharmaceutical executive who helped found a publicly listed company focused on hallucinogens, was the one who introduced him to trading, according to the Financial Times.

This is indeed one trippy story.

By all accounts, Jake Freeman is a bona fide math whiz. He spent summers as an intern at Volaris Capital Management, a firm specializing in “yield and tail-risk opportunities in the options market” whose principals, if not literal rocket scientists, are the investment equivalent.

I don’t doubt that he has the passion, the math chops, and the connections to have pulled this off.

Freeman’s investment fund is a Wyoming LLC, so there’s no transparency as to his investors. (Wyoming and the Dakotas have tax and privacy haven laws that make Switzerland and Cayman Island laws look like swiss cheese in comparison.) It’s unlikely that he had institutional investors.

But given his background, could friends, family, and hedge fund mentors have been willing to throw some capital at the math whiz? Absolutely. Many investment legends traded from their college dorm rooms (Ken Griffin) or bought their first stocks at a tender age (Warren Buffet was 11).

Does his proposal to the board of Bed Bath and Beyond filed with the SEC on July 21, 2022 make sense?

“I noticed how with the right sort of realigning of their debt, they could really reduce their bankruptcy thesis,” Freeman told the Financial Times.

Yes, raising capital and converting fixed debt into convertible debt to take advantage of the volatility inherent in a meme stock adds up on paper. The cash infusion would stave off a liquidity crunch in the near term, assuming that BBBY could turn things around eventually (a big and highly unlikely assumption).

Phoenixes are rare among retailers. 

They tend to die a slow, miserable, and highly leveraged death. In any case, after the rout in meme stocks earlier this year, Freeman thought Bed Bath and Beyond’s stock was too cheap and he saw a way out of likely bankruptcy. 

The price of meme stocks is driven by investor flash mobs of Redditers and day traders. 

As a result, their stock gyrations are untethered to the usual things that affect prices: business results, interest rates, inflation, GDP, overall stock market performance. Meme stocks don’t move in lock step (i.e. they’re not correlated) with the market.

Turning the non-correlated volatility of meme stocks into an asset is genius.

But the logic is a bit tortured and raises another risk: flash mobs by definition are trendy, faddish, and fleeting. In the short run, price is determined by supply and demand, but in the long run, a company is valued by the cash flow it generates.

“The father of value investing, Benjamin Graham, explained this concept by saying that in the short run, the market is like a voting machine—tallying up which firms are popular and unpopular. But in the long run, the market is like a weighing machine—assessing the substance of a company.”

— Morningstar

Financial engineering still requires the business to function IRL.

But because this wasn’t an investment, but speculation, we’ll never know if his plan would have worked. Freeman took to Twitter, Reddit, and GMEdd.com to promote his strategy, which he’d outlined in a letter to BBBY’s board dated July 21, 2022. He’d amassed a 6.21% ownership stake by then.

The stock went on a tear, fueled by the moderators of Reddit forum WallStreetBets lifting a ban on discussing the stock in August. FOMO was a big driver. Then Ryan Cohen, the founder of Chewy.com and chairman of meme stock Gamestop, announced that earlier in the year he’d accumulated a shit ton of call options (right to purchase stocks that are bets the stock will rise), equivalent to a 12% stake.

This catapulted the stock even higher.

But the moment Ryan Cohen subsequently announced the imminent sale of his stake in Bed Bath and Beyond, the stock plummeted. By then Jake Freeman had already sold the stock he’d bought for less than $5.50 at $27.50, timing his exit perfectly.

All of this is fascinating, but here’s what I, a former pro, want to know:

1. Did his investors know that he’d be betting the entire portfolio on JUST ONE STOCK?

That’s a crazy amount of risk.

The gods of finance will tell you that you must diversify, because while you can make a lot of money betting on one horse, if that horse is not Secretariat or Sea Biscuit, you could lose your shirt. 

And if you use leverage you could lose EVERYTHING, and then some. Leverage does not seem to be an issue here. On the flip side, maybe he had another $100 million lying around in cash, uninvested. 

In that case if he were wrong, he would still have capital left to deploy in the hopes of recouping his losses.

Concentration, or having a few well-chosen stocks in a portfolio, is a great way to beat the market. But investing in only ONE stock? Lunacy.

You either have inside information (illegal), or have done so much research you have a giant competitive advantage over other clueless investors.

But here’s the thing.

Even if you are 100% right, you can STILL lose your shirt in the meantime. The trade can go against you longer than you can stay solvent, especially if you borrow money.

I’ve only known one other person who bet the ranch (mortgaged his house, put his entire portfolio in one stock, borrowed every penny he could). He was a financial analyst in the telecom sector and had done enough research to be sure that Qualcomm’s CDMA technology would become the gold standard for cellular networks.

He became a multi-zillionaire as a result and he deserved to be. He took an enormous risk based on having correctly assessed the technology.

Qualcomm was not a meme stock and it was his own money.

If Freeman’s investors didn’t know he was betting the ranch on one stock before, are they comfortable now that they do know? Sure, he made them 5x their investment.

But are they willing to lose as big?

Because in investing it’s as inevitable as the sun rising in the East. If you are right 51% of the time and you make more when right than you lose when wrong, you are a hero.

Even if your batting average is way better than 51%, you will be wrong, you will be wrong often, and you will sometimes be wrong very very big.

2. How was Freeman able to let the stock run?

He thought it would be a six-month play, and that the stock could get to $8 or $9 a share (remember, he’d bought his position below $5.50).

If having a 100% position is just ballsiness verging on outright stupidity, letting a 6% ownership stake in a company run is very, very hard, especially when it rockets through your sell targets.

The tug of war between greed and fear is intense.

How well was he sleeping at night? 

Did he scale out of the position (sell gradually)? 

Was he glued to his quote machine, monitoring every lot traded? 

What happened to make him pull the trigger? (He claims no contact with Cohen.) 

Why that specific moment? 

Did he revise his investment thesis? 

Was there something in the options trading that was a tip off? 

Was volume drying up? 

Was he going on a long-planned vacation with spotty cell service and wanted to enjoy it? 

The media makes it sound like he blew out of his position at $27.50. And if he’d waited just ONE DAY longer, when Ryan Cohen disclosed his plan to sell his stock, Freeman would be kicking himself for round tripping the stock. 

Whether he should have been in the stock at all, or not made it a 100% position, or been right about his financial engineering plan is beside the point.

He traded Bed Bath and Beyond as skillfully as Yo-Yo Ma plays the cello.

I take my hat off to you, Jake Freeman.

What are the takeaways, you ask? 

FOMO is not a good reason to invest

Think of all those poor sods who bought a highly levered meme stock in the $20+ range due to FOMO. They are not just feeling foolish. They are a lot poorer. Fear, desperation, and greed do not make for profitable investing.

Speculative stocks must be watched like a hawk

Short-term, speculative trading requires constant vigilance because when things go south, they go south fast. Having predetermined buy and sell points can be helpful if you can’t watch the tape. Or invest in a less stressful way using a long-term horizon.

Do not speculate on margin

Losing money is bad enough. Losing borrowed money can cause irreparable financial setbacks. You go broke a lot faster when you invest on margin.

Small investors banding together to “stick it to the man” or in this case hedge funds heavily shorting low-priced stocks tap into our love of David vs. Goliath, Robin Hood, or every other story of the underdog vanquishing the overlords.

But mobs make neither great rulers nor great investors, and musical chairs is not a game you want to play with your money.

P.S.

I'll be teaching a class on Financial Intimacy for Business Owners this October. You’ll make better and more profitable business decisions when you approach your financials with curiosity and listen the stories they’re telling you. Sign up here for early bird notification.