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Why Is Everyone Talking About Robinhood Stock?

By Leo Sun – Aug 17, 2021 at 7:45AM

Key Points

  • Robinhood is still a polarizing stock for the bulls and bears.
  • Meme stock investors, Cathie Wood, and the regulators could all cause the stock to remain volatile.
  • Its disruptive potential and growth rates are impossible to ignore.

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Wall Street's most disruptive brokerage continues to dominate headlines.

Robinhood Markets (HOOD -0.74%) went public on July 29, and the online brokerage's stock has already endured some wild swings. The stock opened at its IPO price of $38 a share, ended its first trading day at $34.82, but skyrocketed to $85 a share in early August before tumbling back to the low $50s. Let's see why Robinhood's market debut was so volatile -- and why it continues to attract so much attention.

Embracing the meme stock mania

Robinhood's app, which disrupted traditional brokerages with "free" trades and its streamlined interface, played a central role in the Reddit-fueled short squeeze that propelled shares of GameStop, AMC Entertainment, and other "meme stocks" to historic highs earlier this year.

A smartphone user checks a financial app.

Image source: Getty Images.

Many retail investors conversing through the online forums run on Reddit used Robinhood to buy those stocks, but the company temporarily suspended those trades after its clearinghouse deposit requirements surged to unsustainable levels.

Some investors turned against Robinhood after the debacle, but the company shook off those criticisms, embraced its starring role in the meme stock mania, and portrayed itself as a champion of retail investors. It even allocated 20% to 35% of its IPO shares to its own users.

Many critics scoffed at Robinhood's attempt to turn itself into a meme stock, and its tepid debut initially suggested they were right. However, the stock subsequently more than doubled in value as retail investors jumped in -- even as many investors on Reddit's WSB forum warned others to avoid the stock.

Cathie Wood bets big on Robinhood

Robinhood gained even more steam after famed growth investor and ARK Invest CEO Cathie Wood bought 1.3 million shares for her flagship ARK Innovation ETF (ARKK -0.88%) on the first trading day. Wood subsequently boosted the exchange-traded fund's stake in Robinhood to 4.8 million shares, or 1.1% of the fund's total holdings.

Wood's interest in Robinhood is divisive. The bulls claim Wood has a history of picking big winners like Tesla, while the bears note that ARK's ETFs have broadly underperformed the market this year as growth stocks lost their luster. Many of Wood's latest bets, including Skillz, have also lost value.

Robinhood is gearing up for a secondary offering

Shortly after its public debut, Robinhood filed a secondary offering to allow its pre-IPO investors to sell about 97.9 million shares by automatically converting their convertible notes to stock. 

Robinhood issued many of those convertible notes to remain solvent during the Reddit-fueled short squeeze earlier this year. Robinhood won't receive any proceeds from the sale, but the offering will dilute its existing share count by more than 10%.

That announcement abruptly ended Robinhood's post-IPO rally, which peaked at $85 on Aug. 4. The SEC hasn't approved the secondary offering yet -- and it probably won't happen until after it posts its second-quarter earnings on Aug. 18 -- but it indicates this pricey stock is about to get even pricier.

Unpredictable challenges for PFOF

Robinhood can offer "free" trades because it sells its clients' orders to high-frequency trading (HFT) firms, which profit from the bid-ask spreads. As a market maker, HFT firms can buy stocks at slightly lower prices than the price the Robinhood customer actually pays.

Declining graphs on a red chart.

Image source: Getty Images.

This "payment for order flow" (PFOF) model is widely used by other brokerages, including Morgan Stanley's E*Trade and Schwab, to subsidize their free trades, but it became controversial after Robinhood's platform stalled out during a meme stock rally this spring.

One of Robinhood's biggest backers, Citadel Securities, is a HFT firm that buys Robinhood's orders. Citadel is also a major investor in Melvin Capital, a hedge fund that held a large short position in GameStop. Robinhood's temporary suspension of GameStop trades caused many critics to claim it was doing Citadel's bidding -- an accusation which both Robinhood and Citadel have rejected.

However, the PFOF model still faces a lot of regulatory scrutiny. The U.S. House Committee on Financial Services has reportedly backed off on a plan to ban all PFOF trades -- which would cripple Robinhood's entire business -- but any future challenges could torpedo the stock.

Its planned purchase of Say Technologies

Lastly, Robinhood recently agreed to buy Say Technologies, a communications company that makes it easier for investors to exercise their proxy voting rights and submit questions to management, for $140 million. Robinhood will hold its next earnings call on Say's platform, and it plans to integrate its services into its core app in the near future.

What does this mean for Robinhood's investors?

I cited Robinhood as my top tech IPO to buy last month, and I've remained cautiously optimistic about the stock after its market debut. Its disruption of traditional brokerages, its resilience among younger investors, and its jaw-dropping growth rates all make it impossible to ignore -- even if the stock seems expensive at 44 times last year's sales.

Robinhood's stock will remain volatile as the meme stock investors, Cathie Wood, the bears, and the regulators all weigh in on Robinhood's future. Investors with an appetite for risk should consider nibbling on the stock as it fluctuates, but they shouldn't be surprised if this wild stock gets cut in half again.

Charles Schwab is an advertising partner of The Ascent, a Motley Fool company. Leo Sun owns shares of ARK Innovation ETF. The Motley Fool owns shares of and recommends Skillz Inc. and Tesla. The Motley Fool recommends Charles Schwab. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Robinhood Markets, Inc. Stock Quote
Robinhood Markets, Inc.
HOOD
$9.39 (-0.74%) $0.07
ARK Innovation ETF Stock Quote
ARK Innovation ETF
ARKK
$36.00 (-0.88%) $0.32

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