When Robinhood (HOOD -1.76%) came to the public markets in July 2021, it was one of the most anticipated IPOs of the year. Shares closed at $70.39 just a few days after the IPO, an 85% increase. It's been a steady decline for the share price since then, and the most recent quarter's results haven't helped. For investors who may have been considering buying shares of Robinhood, it's worth looking instead at Charles Schwab (SCHW -0.05%) for an online broker that has provided better results for shareholders.
Image source: Getty Images
Robinhood's business model
Before diving into the last quarter's results, it's important to understand how Robinhood makes its money. The bulk of Robinhood's revenue comes from what it calls transaction-based revenue, but it's more commonly known as payment for order flow.
Essentially, Robinhood makes tiny amounts of profits on every trade by routing those trades to certain market makers. The customer gets a slightly less advantageous price on the trade as a result. While payment for order flow is not unique to Robinhood, the amount to which the company relies on this revenue model is uncommon. Last quarter, 73% of Robinhood's revenue came from payment for order flow. By comparison, in the same quarter, Schwab's trading revenue -- which is partially comprised of payment for order flow -- was only 21% of total revenue. Online brokers moved to payment for order flow as a revenue stream when they eliminated trading commissions.
Unpredictable results
Robinhood's most recent results featured some significant slowdowns from the previous quarter. While year-over-year revenue was up 35% in Q3, that was a drop sequentially from the 132% year over year growth seen in Q2. At the same time, operating expenses were 596% higher than the year ago quarter, rising to become 496% of revenue. This resulted in a net loss in the quarter of $1.3 billion. Turning to user metrics, net cumulative funded accounts, monthly active users, assets under custody, and average revenue per user were all down sequentially. For current or potential investors, this quarter was an example of the volatility that can be expected with a company that has so much revenue dependent on payment for order flow. Results will always be tied to trading volume, which is unpredictable.
A rock-solid alternative
Charles Schwab, on the other hand, had positive results last quarter. Unlike Robinhood, the bulk of Schwab's revenue comes from net interest revenue, which was 44% of total revenue last quarter. In Schwab's Q3, year-over-year revenue and net income grew 87% and 119%, and operating expenses were down 9% sequentially from Q2. Core net new assets also grew 28% sequentially to a third quarter record of $139 billion, and total client assets reached $7.6 trillion.
By comparison, Robinhood's assets under control in Q3 was $44 billion, a far cry from Schwab's total. Shareholders of Schwab not only benefit from steady, proven business, they're also seeing impressive growth coming out of the pandemic. Year-over-year revenue growth has exceeded 60% in each of the last 4 quarters.
Less worry, more return
For those considering Robinhood as an investment, the unpredictability of its revenue and the resulting pressure that can put on the share price is worth considering. Since its IPO, Robinhood is losing to both Schwab and the S&P 500.
This last quarter showed how the whims of trading can impact Robinhood's results. The ups and downs are likely to continue because of this, coupled with the fact that the company is brand new to the public markets. With its improving revenue growth, track record of profitability, and its dividend, investors can expect a better return and a better night's sleep putting their money on Charles Schwab instead.
