Robinhood Markets, the zero-commission online brokerage popular among millennials, has seen its stock price decline by about 16% over the last week (five trading days) to about $47 per share. This compares to the S&P 500 which was up by roughly 1% over the same period. Although there wasn’t much negative news relating to the company in the past week, Robinhood has emerged as a “meme” stock of sorts, with its price movement dictated by interest from retail traders and other technical factors such as its float. The company allocated about 35% of its IPO shares to retail investors and also had relatively lax IPO lockup rules, translating into a higher float and more volatility. Moreover, the stock saw a major rally post its listing, rising by as much as 85% from its IPO price of about $38 at one point earlier this month and this has likely caused investors to book some profits.
So is the stock a buy at current levels? While Robinhood has fared well in recent years as it remains the go-to app for millennials looking to trade stocks, we think the stock is a bit overvalued trading at almost 20x forward revenues. Although the valuation is partly justified by the company’s solid growth, with sales expected to roughly double this year, there are risks as well. With inflation on the rise and the U.S. Federal Reserve looking at rate hikes for 2023, a year ahead of initial expectations, there’s a strong possibility that the stock markets could see limited gains or even a correction, impacting brokerage businesses. Robinhood is more dependent on trading revenues and could be more adversely impacted by a pullback compared to rivals, who rely more on interest revenues. The company’s business model of generating revenue via Payment for Order Flow has also proved somewhat controversial. The SEC indicated that it was reviewing the PFOF model and this could also create an overhang on the stock.
We value Robinhood stock at about $39 per share, indicating a downside of about 17% from the current market price. See our analysis on Robinhood Markets Valuation: Is HOOD Stock Expensive Or Cheap? for more details on HOOD stock’s valuation and comparison with peers.
Robinhood stock: What are the risks?
Robinhood Markets, the zero-commission online brokerage, went public last week. Although the stock was off to a rocky start, with prices briefly dipping below the IPO price of about $38 per share, it now trades at about $47 per share, giving the company a market cap of roughly $40 billion. Robinhood has a lot going for it, as it remains the go-to app for millennials looking to trade stocks, with growth surging through the pandemic. For example, funded accounts rose to over 22 million as of June 2021, up almost 4x since the end of 2019. The company also has a fast-growing cryptocurrency business and with its large and engaged user base, it’s possible that it could venture into providing other financial services as well. That being said, we see a couple of key risks for the stock at this point.
The S&P 500 is now up by over 90% from the lows of March 2020. With inflation on the rise and the U.S. Federal Reserve also looking at rate hikes for 2023, a year ahead of initial expectations, there’s a strong possibility that the stock markets could see limited gains or even a correction, impacting brokerage businesses. While this is a risk that all brokers face, the impact on Robinhood could be more pronounced as the company largely caters to first-time investors who could scale back on trading as markets decline. Moreover, Robinhood appears to be more dependent on transaction-related revenues (payment for order flow) versus its peers. About 75% of the company’s revenues were dependent on transactions last year. In comparison, E-Trade, now acquired by Morgan Stanley MS -1.6%, derived roughly 65% of its revenues from interest income in 2019.
Robinhood’s bread-and-butter payment for order flow business - which entails selling the order flow of its retail customers to market makers and high-frequency trading firms - is also controversial, with critics arguing that it could effectively give retail investors a worse price on their trades. In June, the SEC indicated that it was reviewing payment for order flow, causing some speculation that the practice, which is already illegal in countries such as the U.K., could be banned in the U.S. as well. While PFOF has more or less become a standard practice for Robinhood’s rivals such as Charles Schwab and E-Trade, they are less dependent on it as a revenue stream, given their larger interest-related revenues and other services.
Separately, there are some technical factors that could impact the stock. The company said that it would sell about 35% of its IPO shares to retail investors. This is in contrast with other companies who have typically allocated well below 10% of the stock for sale to individuals, setting aside a bulk of stock for institutional investors and high-net-worth individuals, who often have a longer-term investment horizon. This could make the stock more susceptible to big movements. For example, the stock rallied by 24% on Monday alone, for no apparent reason. It’s likely we could see similar swings on the downside as well. Robinhood also has looser post IPO lockup rules. Insiders were allowed to sell 15% of their holdings from the time the company went public, with another 15% apparently being freed up within three months. This could translate into a higher supply of stock, putting pressure on the stock price in the near term.
See our analysis on Robinhood Markets Valuation: Is HOOD Stock Expensive Or Cheap? for more details on HOOD stock’s valuation and comparison with peers.
How Does Robinhood Markets Make Money?
Robinhood Markets, the zero-commission online brokerage popular with millennials, is expected to go public next week trading under the ticker HOOD on the Nasdaq NDAQ -1.6%. The company will offer shares at between $38 to $42 apiece, potentially translating into a valuation of as much as $35 billion. In our dashboard Robinhood Markets Revenues: How Does HOOD Make Money? we provide an overview of Robinhood’s business model and its key revenue streams. Parts of the analysis are summarized below.
Robinhood’s Business Model
Robinhood is an online brokerage that offers commission-free trades of stocks, exchange-traded funds, and cryptocurrency. Although Robinhood doesn’t directly charge its users for trades, it primarily makes money from market makers and frequency trading firms who pay for the order flow from its retail traders. Payments for order flow, or PFOF, accounted for roughly 75% of the company’s revenue last year. Additionally, Robinhood also earns revenue from interest on securities and margins loans. The company also offers other services including the Robinhood Gold premium subscription service, which gives users access to features including professional research and margin trading.
How Have Revenues Trended?
Robinhood has seen its transaction-based revenues grow 320% from around $170 million in 2019 to about $720 million in 2020. In Q1 2021, transaction revenues grew further by about 340% year-over-year to $420 million. The revenue surge comes as more retail investors have been attracted to the stock markets given the big bull run through the Covid-19 pandemic and more recently, the meme stock trading frenzy. For perspective, the number of funded accounts on Robinhood grew from around 5.1 million at the end of 2019 to about 12.5 million in 2020 and stood at an estimated 22.5 million as of the end of June 2021. The retail trading frenzy has also meant that Robinhood is able to better monetize its users. The average revenue per user rose from $65.70 in 2019 to $108.90 in 2020 and to about $137 in Q1 2021, on an annualized basis.
Although options remain the largest driver of Robinhood’s transaction revenue (47% of sales), the cryptocurrency business is the fastest-growing. In Q1 2021, crypto-related revenue soared by around 20x year-over-year to almost $88 million. Apart from the core transactions business, Robinhood’s other segments have also been expanding, with net interest revenue and other revenue together rising by almost 3x in Q1 compared to last year. That said, Robinhood is actually getting more dependent on its transaction revenues, which accounted for almost 81% of sales over Q1, versus about 75% last year.
What Are The Risks?
While Robinhood’s recent sales growth has been robust, there are near-term risks. The stock markets could be peaking, with the S&P 500 now up about 90% from the lows of March 2020. Moreover, inflation is on the rise, and the U.S. Federal Reserve is also looking at rate hikes for 2023, a year ahead of initial expectations. A sharp market correction or even sideways movement could limit interest in Robinhood’s platform, which largely caters to first-time investors. Separately, Robinhood’s bread-and-butter payment for order flow business model is also controversial, with critics arguing that it could effectively give retail investors a worse price on their trades. Last month, the SEC indicated that it was reviewing payment for order flow, causing some speculation that the practice, which is already illegal in countries such as the U.K., could be banned in the U.S. as well. While PFOF has more or less become a standard practice for Robinhood’s rivals such as Charles Schwab and E-Trade, they are less dependent on it as a revenue stream, given their larger interest-related revenues and other services.