Here are the six key things you need to know if you are thinking about buying shares of Robinhood Markets Inc. The initial public offering priced Wednesday, and the shares start trading Thursday.
Robinhood, which operates a popular securities-trading platform, priced the shares at $38 each, the low end of a range.
There are three good things and three bad to know about Robinhood, which will be traded on the Nasdaq.
Let’s start with the three positives.
Growth is off the charts
The app is cool and easy to use. So … growth is amazing. Last year, Robinhood
accounts grew 143% to 12.5 million, and revenue surged 245%. That continued in the first quarter, when accounts rose by 151% to 18 million and revenue increased 309%, year over year.
Detractors try to use this against the company, saying Robinhood’s interface turns investing into a game. But only people, not an app, can determine if they approach investing as a game or not.
Smart investors I know cite this as a key quality. They look for companies that get a foothold with customers and then grow by selling them more services. This is a core strategy at Robinhood. Its phenomenal growth put the app in the lives of tens of millions of young investors. They’ll need more financial services as they get 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, car loans, IRA and Roth IRA accounts, crypto wallets — and who knows what else.
It’s a disrupter
Half of all brokerage accounts opened in the U.S. from 2016 to 2021 have been set up on Robinhood, the company has estimated. That’s an impressive stat, given that competitors such as stalwarts Charles Schwab
and Fidelity Investments aren’t exactly shabby. More than 80% of Robinhood’s clients come by word of mouth, another data point that tells you Robinhood is disrupting the brokerage world.
Like a lot of disrupters, Robinhood is founder-run. This is a plus for investors. Founders like Jeff Bezos at Amazon are passionate about their businesses, and they keep innovating even after they have made their billions. Investors go along for the ride. Robinhood was founded in 2013 by Vladimir Tenev and Baiju Bhatt, and they still lead the company.
And now, the three negatives.
Retail investing may slow
Robinhood will come public with a market capitalization of $37 billion and an enterprise value of $30 billion (market cap minus net cash), assuming it’s priced at $40.
This is a very rich valuation relative to competitors like Schwab and Interactive Brokers
True, Robinhood is growing much faster — 245% in 2020 compared with 12% for Interactive Brokers and 9% for Schwab. To hold the rich valuation, Robinhood will have to keep up the rapid growth. It’s not clear this will happen.
“At a $37 billion market cap, a lot of growth is baked in. As people return to the office and go out again and do social activities, we don’t know if trading is going to be as popular a pastime,” says Matthew Kennedy, senior strategist with Renaissance Capital, which manages the IPO exchange traded fund Renaissance IPO ETF
“That is the major concern.”
True, but to some extent a slowdown in growth is already partly priced in to the stock. Robinhood has told investors to expect an outright decline in revenue in the third quarter. Shares of Interactive Brokers have sold off recently on weak guidance, and Schwab was hit by this too.
Of course, the really big risk is a bear market. Not the kind of brief selloffs we have seen this year, but a nasty bear market — the kind that makes people swear off stocks forever.
Among brokerages, Robinhood would get hit particularly hard since much of its revenue comes from riskier areas of trading like options (38%) and crypto (17%) that will dry up the fastest. Of course, crypto has a life of its own so it might continue to do well, even in a bear market and recession.
The question is whether Robinhood will roll out enough other products to diversify revenue away from trading before the next bear market comes.
Regulators may ding the business model
“Payment for order flow” are the new dirty words among Wall Street critics. Robinhood and other retail brokerages have replaced commissions with payment for order flow from market makers like Citadel Securities. They make money by skimming fractions off trades.
Critics think this opens investors to abuse, and regulators are looking into it. “The risk is regulators say ‘I am taking away 80% of revenue,’ ” says Kennedy. Robinhood gets about 80% of revenue by directing client trades to market makers.
In my view, this model is great for retail investors because it lets them start positions gradually with small purchases, and average down on weakness. In the old days, retail investors were more apt to just by the whole position in the first swipe to save on commissions.
I think the tradeoff is worth it. Regulators may not agree. On the other hand, so much of the brokerage sector now makes money from this practice, there’s a strong lobbying contingent supporting it.
The Reddit crowd trashes Robinhood
They’re angry at Robinhood for limiting trading in the meme stocks AMC Entertainment
when their spikes created credit risk in the stock settlement system, earlier this year. Robinhood limited trading briefly to keep the risks from rising, but it wasn’t the only one to blame. The risk managers behind the clearance system hadn’t anticipated the crazy moves in stocks, either.
As influential as the various Reddit trading groups can be, so far their negativity hasn’t hurt Robinhood. Second-quarter growth was phenomenal.
In a July 27 filing, Robinhood said funded accounts grew 25% to 22.5 million in the second quarter, from 18 million in the first quarter. Robinhood also put second-quarter revenue at $546 million and $574 million, a 129% increase at the midpoint from the $244 million in the second quarter of 2020, and 7.3% sequential growth over the first quarter.
We should never underestimate the power of the Reddit crowd. But also remember that a lot of people hated (and shorted) Facebook
and Netflix when they first came public.
And look where their stocks have gone.
Michael Brush is a columnist for MarketWatch. He has a Robinhood account. At the time of publication, he had no positions in any stocks mentioned in this column. Brush has suggested SCHW, FB, AMZN, GOOGL and NFLX in his stock newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks.