Online investing platform Robinhood Markets (HOOD 2.47%) has been a disaster for investors. The stock went public last summer and has fallen more than 80% from its highs at $85 a share to well below its $38 IPO price. Robinhood built its brand on retail investors, who seem to be running away from the platform if judging by its quarterly results.
However, don't be too quick to dismiss Robinhood as an investment moving forward. The emotional behavior of retail investors made me realize that Robinhood itself might be a cyclical business. What does that mean? I'll explain this below, and show you why Robinhood's best days may still be ahead.
Robinhood is a cyclical business
Cyclical stocks are often associated with industrial companies or oil markets. These companies do well during times of "peak" operating conditions. For example, an industrial company will perform well when the economy is humming along, but falter during a recession. Similarly, an oil stock's profits gush when oil prices are high, and dry up when they aren't. In other words, cyclical businesses go through boom and bust cycles, hence the term "cyclical."
For Robinhood, there could be a similar trend at work. Consider that Robinhood markets to young, inexperienced traders. The average Robinhood user is 31 years old, and half of its users are first-time traders. That's reflected in the median account value, which for Robinhood is $240.
I'm just going to say this bluntly: Investing can be hard. Emotions can get the best of investors, whether you're just starting or you've been in the stock markets for decades. However, many younger or inexperienced investors haven't experienced an entire market cycle (both bull and bear markets).
Many Robinhood users' first experience in stocks might have been during 2020, when the flood of stimulus money and very low interest rates helped contribute to a stock market that embraced speculation in early 2021. Many high-growth stocks rose hundreds of percentage points, producing what's usually years' worth of returns in just weeks or months.
I don't think it's a stretch to say that the fear of missing out, or "FOMO," may have caused many investors to pile into stocks, trying to ride the upward momentum. You can almost trace this in Robinhood's quarterly user metrics. Monthly active users (MAU) grew from 11.7 million in Q4 of 2020 to 21.3 million in Q2 of 2021, almost doubling in six months.
Things have somewhat reversed since then, with many of the stocks that rose so high so quickly steadily falling over the last nine months. Just like many of these once high-flying stocks have fallen, so have Robinhood's MAUs. Its user count fell to 18.9 million in 2021 Q3, and 17.3 million in Q4.
Need a litmus test for this theory? Looking at Alphabet's Google search engine traffic over the past year will show that search activity for "stocks" has fallen 77% year over year from February of 2021. Google search activity for "Robinhood" peaked in early May 2021, and has fallen 88% since then. In other words, investors aren't as interested in stocks when they keep falling, and it's showing up in Robinhood's operating results.
Robinhood could bounce back
So what to make of this? The first thing is that Robinhood's business will likely bounce back to some degree eventually. Nobody can predict the market; I know that I can't. Still, the market is undergoing a severe correction -- high inflation has made it more likely that interest rates increase, which typically hurts stock valuations. A whopping 80% of stocks in the Nasdaq Composite are currently below their 200-day moving average, a sign that most stocks in the index have negative price action. Many have fallen more than 20%, putting them in "bear market" territory.
The stock market itself goes through periods of ups and downs over the years, and stocks will probably regain positive momentum at some point, even if investors must wait a while for that to happen. When it does, however, Robinhood could recover a lot of those lost users. The platform has gained a reputation for a simple user interface, free trading, and low-margin interest rates, all aimed at attracting retail investors.
Robinhood should put up strong financials when this happens. The company put up positive earnings before interest, taxes, depreciation, and amortization (EBITDA) in 2020 Q4, 2021 Q1, and 2021 Q2 before user activity started sliding. EBITDA was negative $84 million and negative $87 million in the two following quarters, 2021 Q3 and 2021 Q4.
Is Robinhood stock a sure thing? Absolutely not. Maybe investors who left the platform don't return, or they go to a more traditional brokerage. Perhaps the company cannot consistently turn a profit even when user activity does bounce back. Regulators could even frown on paying for order flow, which is how the company makes the majority of its revenue.
But remember that the stock price has fallen tremendously. At a market cap of just $11.5 billion, the platform still has more users than many other brokerages, including the big players like TD Ameritrade at 11 million. The stock's price-to-sales ratio is just 6, so if Robinhood's business model can prove successful over the long term, there's room for the stock to appreciate from here.