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Should You Buy Robinhood Stock When It IPOs?

By Brett Schafer - Updated Jul 14, 2021 at 4:53PM

Key Points

  • Robinhood's business is growing rapidly.
  • But some key drivers of its business might owe to short-term market enthusiasm.
  • Reports of its IPO value indicate it's going to be very richly valued.

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The popular mobile trading app is hitting the public markets soon.

One of the most well-known private companies in the U.S. is going public this summer: Robinhood. The controversial mobile trading platform that has surged to the top of the app rankings in recent years just dropped its S-1 (the SEC filing required before an initial public offering), indicating the company's stock will make a public debut shortly.

Should you buy shares in Robinhood when it IPOs? Let's dig deeper into the S-1 and find out.

Person surrounded by computers looking at  phone.

Image source: Getty Images.

The business is growing rapidly

Robinhood is one of the fastest-growing businesses in the world. At the end of March, cumulative funded accounts hit 18 million, up 151% from the same period a year ago, when it had 7.2 million. This rapid user growth has led to strong sales growth, as well. In 2020, Robinhood's revenue hit $959 million, up a whopping 245% from 2019, and in the first quarter of 2021, sales growth accelerated to 309% -- the company brought in $502 million just in that three-month period.

Even though Robinhood offers free trading to its customers, it still makes money off trades by selling customer orders to market makers like Citadel Securities in a process called payment for order flow (PFOF). This relationship is normally invisible to investors, but it made headlines earlier this year when it faced liquidity questions as a slew of traders bought and sold shares and options contracts of GameStop and other stocks touted on Reddit's Wall Street Bets community. As a result of the episode, Robinhood raised more than $3 billion from its investors through two tranches of convertible notes that are still on the balance sheet today.

Robinhood also brings in money through net interest income (12% of revenue) and through its premium subscription product called Robinhood Gold (7.5% of revenue). The rest of its revenue currently comes from PFOF.

Robinhood has large transaction and customer support expenses, which came to 26% of Robinhood's revenue in 2020. If these expenses grow in tandem or faster than revenue, Robinhood may struggle to achieve strong profit margins. Other brokerages like Charles Schwab have historically had strong profit margins north of 40%, but they operate different business models than Robinhood, so it is unclear what sort of margins Robinhood will reach at scale.  

Know before you buy

The company's business is growing quickly, but it's doing so in ways that investors will have to watch over time. For one, in 2020, 46% of Robinhood's PFOF revenue came from options trading. It is estimated that the majority of options traders, possibly up to 95% of them, lose money over time. Opening up options trading to its customers might make money for Robinhood in the short run, but if they continually lose money, users might reconsider the value Robinhood provides to it and leave the service.

Robinhood has also seen huge growth in cryptocurrency revenue, up almost 2,000% in this year's first quarter, making up more than 20% of transaction-based revenue during the period. This doesn't sound too bad (and that growth looks great). However, 34% of this cryptocurrency revenue came from Dogecoin, a token that was created entirely as a joke. It is unclear whether this revenue can be sustained for Robinhood going forward as it relies on overall investor sentiment for cryptocurrencies.

Expect a steep valuation

According to reports from S&P Global analysts, Robinhood is likely to debut at a market cap of $30 billion or more. With 2020 revenue under $1 billion, this could put Robinhood's trailing price-to-sales ratio (P/S) at 30 or higher, which is richer than almost every other stock on the market.

Robinhood is growing quickly, and if it can keep up its triple-digit revenue growth, the sales multiple should compress over the next few years. But investors need to ask themselves two questions: How sustainable is this revenue? And what type of profit margins can Robinhood get to at scale? Its high costs and reliance on customers' willingness to trade options and Dogecoin are risks to Robinhood stock that any investor should consider.

So should you buy shares?

If Robinhood's market cap comes out at $30 billion or higher, it is likely wise for any investor, especially those with a lower tolerance for risk, to avoid buying the stock at the IPO. While it's exciting and growing quickly, given the company's business dynamics and reliance on Dogecoin for revenue, the stock looks incredibly risky. There's no doubt Robinhood is the leading smartphone trading app, but that doesn't mean it belongs in your portfolio.

Brett Schafer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Dogecoin Stock Quote
Dogecoin
DOGE
$0.07 (4.25%) $0.00
The Charles Schwab Corporation Stock Quote
The Charles Schwab Corporation
SCHW
$75.00 (3.35%) $2.43
GameStop Corp. Stock Quote
GameStop Corp.
GME
$40.74 (3.27%) $1.29

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