The world is still living alongside a global pandemic, but many of the worst restrictions have subsided. The economy has reopened, and day-to-day life has mostly returned to normal. But there's a key pandemic-era trend that has completely reversed.
Throughout 2020 and 2021, retail investors flooded the stock market with their pandemic stimulus checks, rushing into high-flying growth stocks with little regard for price or valuation. Their trading platform of choice was Robinhood Markets (HOOD), resulting in millions of new customers for that company and a supercharged growth rate for its business.
Robinhood took advantage of the ideal environment and listed its own stock on the public markets. Investment bank Goldman Sachs was the lead underwriter, meaning it was responsible for raising money on behalf of Robinhood to make its initial public offering (IPO) possible -- and it pulled this off successfully.
Robinhood stock soared to an all-time high of $85 per share shortly after listing in August 2021, but it has since collapsed by 87% as the pandemic-driven retail investor frenzy dissipated. Now, Goldman Sachs is telling investors to sell Robinhood stock. Here's why.
Image source: Getty Images.
Robinhood has a growth problem
Investors want to own stock in companies that are growing. If a company doesn't expand its user base, revenue, or even its profits, its stock price will typically fall resulting in a loss of opportunities.
Goldman Sachs cited a couple of key issues when it told investors to sell Robinhood stock earlier this month. One of them was a shrinking user base, a trend that has persisted for two consecutive quarters.
Chart by author.
But perhaps more concerning is Robinhood's average revenue per user, which has crashed by 53% since peaking at $137 in the first quarter of 2021.
The company doesn't charge commissions like a traditional broker; instead it makes money through a practice called payment for order flow (PFOF). PFOF has been under intense scrutiny by regulators over the last couple of years because it costs retail investors more in hidden fees, despite claims to the contrary.
Since Robinhood is a trading platform focused on small retail investors, the absence of further economic stimulus checks and a waning interest in stocks among that cohort leaves few paths for the company to turn things around. Put simply, it was the beneficiary of an extremely unique environment that is unlikely to repeat anytime soon.
The end result
The aforementioned decline in key business metrics has resulted in extremely poor financial performance for Robinhood as a company, with falling revenue and losses that extend deep into the red.
Chart by author.
Robinhood estimated that in the first quarter of 2022 that it could generate $340 million in revenue. That would represent a 35% decline compared to the first quarter of 2021, and to reaffirm a previous point, it's almost never a good idea for investors to own stock in a shrinking business.
The company is aiming to rebuild its image by offering products that help the retail crowd invest for the long term. While this is noble, Robinhood's revenue is mostly transaction-based, so the more frequently its users trade, the more money it generates. Therefore, having users transact less would be a significant shift in its business model.
Time will tell whether Robinhood can morph into a mainstay in the financial services industry. But right now all signs point to more pain for those who hold its stock, so following Goldman Sachs' advice might be prudent for the moment.
