Opinion: Three arguments for and three against buying Robinhood stocks once they start trading after the IPO
Here are the top six things to know when considering Robinhood Markets Inc stock. to buy. The IPO is priced on Wednesday and the stock will begin trading on Thursday.
Robinhood, which operates a popular securities trading platform, has priced the stock at $38 each, the low end of a range.
There are three good and three bad things to know about Robinhood, which will trade on the Nasdaq.
Read: Why stock trading apps like Robinhood plus social media are a potent concoction for investors
Let’s start with the three positives.
Growth is off the charts
The app is cool and easy to use. So…growth is great. Last year Robinhood HOOD
accounts grew 143% to 12.5 million, and revenue grew 245%. That continued into the first quarter, when the number of accounts grew 151% to 18 million and revenue grew 309% year over year.
Opponents try to use this against the company, saying that Robinhood’s interface turns investing into a game. But only people, not an app, can determine whether they approach investing as a game or not.
I know savvy investors mention this as an important quality. They look for companies that gain a foothold with customers and then grow by selling them more services. This is a core strategy at Robinhood. Its phenomenal growth brought the app into the lives of tens of millions of young investors. They will need more financial services as they grow older and accumulate wealth, and Robinhood will be there to provide.
This means things like debit cards, credit cards, an enhanced level of service called Robinhood Gold, auto loans, IRA and Roth IRA accounts, crypto wallets – and who knows what else.
It’s a disruptor
Half of all brokerage accounts opened in the US between 2016 and 2021 are set up on Robinhood, the company estimates. That’s an impressive stat, given that competitors like the trusty Charles Schwab SCHW,
and Fidelity Investments aren’t exactly shabby. Over 80% of Robinhood’s clients come through word of mouth, another data point that tells you that Robinhood is disrupting the real estate world.
Investing in disruptors including Amazon.com AMZN,
or Netflix NFLX,
can pay off, as disruptors tend to find new ways to disrupt after their early successes.
Like many disrupters, Robinhood is founder-run. This is a plus for investors. Founders like Jeff Bezos of Amazon are passionate about their business and continue to innovate even after making their billions. Investors go along for the ride. Robinhood was founded in 2013 by Vladimir Tenev and Baiju Bhatt, and they still run the company.
And now the three negatives.
Retail investing can slow down
Robinhood will go public with a market cap of $37 billion and an enterprise value of $30 billion (market cap minus net cash), assuming the price is $40.
This is a very rich rating against competitors such as Schwab and Interactive Brokers IBKR,
It is true that Robinhood is growing much faster – 245% in 2020 compared to 12% for Interactive Brokers and 9% for Schwab. To maintain the rich valuation, Robinhood will have to sustain the rapid growth. It is not clear that this will happen.
“With a market cap of $37 billion, there is a lot of growth ingrained. As people return to the office and go out and do social activities, we don’t know if trading will become such a popular pastime,” said Matthew Kennedy, senior strategist at Renaissance Capital , which manages the IPO exchange traded fund Renaissance IPO ETF IPO,
“That’s the biggest concern.”
That’s true, but to some extent, a slowdown in growth is already partly priced into the stock. Robinhood has told investors to expect an outright drop in revenue in the third quarter. Shares of Interactive Brokers recently sold after weak guidance, and Schwab was also affected.
The really big risk, of course, is a bear market. Not the kind of short sale we’ve seen this year, but an annoying bear market — the kind that makes people swear off stocks forever.
Among brokers, Robinhood would be hit particularly hard, as much of its revenue comes from riskier trading areas like options (38%) and crypto (17%) which will dry up the fastest. Of course, crypto has a life of its own, so it can continue to thrive even in a bear market and recession.
The question is whether Robinhood will roll out enough other products to diversify trading earnings before the next bear market comes.
Regulators can influence the business model
“Payment for flow of orders” are the new dirty words among Wall Street critics. Robinhood and other retail brokers have replaced commissions with order flow payments from market makers like Citadel Securities. They make money by skimming fractions of transactions.
Critics believe this exposes investors to abuse, and regulators are investigating. “The risk is that regulators say, ‘I’m taking 80% of the revenue,'” Kennedy says. Robinhood makes about 80% of its revenue by directing transactions from customers to market makers.
In my opinion, this model is great for retail investors as it allows them to gradually take positions with small buys and average down on weakness. In the past, retail investors were more likely to just save on commissions through the entire position in the first swipe.
I think the trade-off is worth it. Regulators may disagree. On the other hand, so much of the brokerage now makes money from this practice that there is a strong lobbying contingent supporting it.
The Reddit Crowd Is Destroying Robinhood
They are angry with Robinhood for restricting trading of the meme stock AMC Entertainment AMC,
and GameStop GME,
as their spikes earlier this year created credit risk in the equity settlement system. Robinhood briefly curtailed trading to avoid increasing risks, but it wasn’t the only one to blame. The risk managers behind the clearing system weren’t expecting the crazy moves in stocks either.
As influential as the various Reddit trading groups may be, so far their negativity hasn’t hurt Robinhood. Growth in the second quarter was phenomenal.
In a filing on July 27, Robinhood said funded accounts grew 25% in the second quarter to 22.5 million, from 18 million in the first quarter. Robinhood also estimated second-quarter revenue at $546 million and $574 million, up 129% in the middle from $244 million in the second quarter of 2020, and 7.3% sequential growth in the first quarter.
We should never underestimate the power of the Reddit crowd. But also remember that many people hated (and shorted) Facebook FB,
and Netflix when they first went public.
And see where their shares have gone.
Michael Brush is a columnist for MarketWatch. He has a Robinhood account. At the time of publication, he had no holdings in any of the stocks mentioned in this column. Brush featured SCHW, FB, AMZN, GOOGL and NFLX in his stock newsletter, Polishing stocks. Follow him on Twitter @mbrushstocks.