If you're reading this then you've almost certainly heard of Robinhood Markets (HOOD 4.44%), the commission-free trading app that became all the rage during the early days of the pandemic, when bored people turned to stock trading for entertainment. Many of the so-called meme stocks also seem to be favorites among Robinhood's relatively new investors.
Conversely, despite being around for much longer than Robinhood, it's likely you're less familiar -- or not familiar at all -- with SoFi Technologies (SOFI 3.69%), despite its broader range of app-based offerings.
Don't confuse notoriety with sustainable success, however. A lot of companies are better at creating attention than generating profit-driven growth. SoFi's not just the better bet in this regard, but an overall good bet for investors looking to add some growth prospects to their portfolio.
The same, but different
With nothing more than a passing glance the two companies look comparable enough. Robinhood Markets is focused on stock trading, though its planned Cash Card will help customers readily access the money held in their account. SoFi Technologies offers a mix of loans and banking services as well as online investing, and in the same vein as Robinhood, ultimately aims to send people to the company's app. Anything one of these companies does could be mimicked by the other in relatively short order.
Yet these two organizations are considerably different in ways that really count.
Image source: Getty Images.
Much of this disparity reflects how each of these two app-centric outfits sparked their earliest growth. For SoFi, at its 2011 launch it was exclusively a lender, cashing in on the then-budding peer-to-peer lending craze. While it's added banking, credit cards, and investing to its repertoire since then, it's still first and foremost a lender, adhering to all the rules and standards that apply to the industry.
Robinhood's history is different. It was launched in 2014 exclusively as a commission-free stock trading app meant to democratize trading. While it's tacked on features like crypto trading and the aforementioned Cash Card in the meantime, stock trading is still its focus. That's why it was such a hit during the earliest phase of the pandemic -- it gave people an activity they craved.
That little detail has since evolved into a not-so-little problem for Robinhood, exacerbated by the very customers it could have expected to attract to the app.
Riskier than it seems on the surface
Although Robinhood doesn't charge investors commissions on stock trades, there is still ultimately a cost for investors.
Robinhood Markets' revenue largely stems from what's called payment for order flow. That just means middlemen that make money by facilitating stock trades send some of that money back to the broker, in this case Robinhood. The company collected $1.4 billion worth of this transaction-based revenue last year, nearly doubling 2020's tally, and accounting for more than three-fourths of its top line.
It's not illegal -- at least not yet. But, the idea is under fresh scrutiny. Ironically, the Securities and Exchange Commission's (SEC) consideration of banning the practice of payment for order flow has been countered by legislative efforts meant to prevent the SEC from making such a ruling. At the heart of the debate is whether the model presents a conflict of interest, and whether consumers are actually harmed or helped by the commission-free trading business model -- it's not always clear.
One thing is clear, though: Even if payment for order flow isn't outlawed, change is likely, posing a threat to Robinhood's core business.
It's not just prospective rule changes that could present problems for Robinhood. It's also arguable that many of the clients its platform has attracted since its inception (and particularly since the coronavirus pandemic took hold) might be the most sensitive to any such rule changes or, if necessary, the imposition of trading commissions.
See, the typical Robinhood customer is a first-time investor, with an average account balance of only between $4,000 and $5,000, although the median account is likely to be much smaller. Given that many of these investors also only opened accounts during the throes of the pandemic to replace time usually spent, say, watching professional sports -- which had been halted at the time -- this sliver of its users may well lose interest in stocks at even the slightest of cost increases.
Indeed, they may be losing interest anyway. Analysts believe the company's revenue will contract slightly in 2022, with actual profits still years away even if Robinhood's past revenue growth pace is rekindled next year. And now, after rapid expansion, Robinhood is retrenching, and this week it announced a 9% reduction in headcount. Also know that Robinhood was fined $70 million last year for, among other things, "systemic supervisory failures" that led to customers being given "false or misleading information."
Data source: Thomson Reuters. Chart by author. All figures are in millions of dollars.
Read between the lines. Brokerage is a tough business to begin with. It's even tougher for a newcomer catering to new investors with small accounts.
None of this is to suggest Robinhood Markets is beyond redemption, as a brokerage firm or as an investment. It is to say, however, there may be even bigger philosophical, legal, and strategic challenges in place here than the headlines adequately suggest.
Don't be afraid to play it smart by playing it safe
SoFi Technologies isn't facing the same problem or potential regulatory headwinds. That's because the lending business isn't facing sweeping rules changes, and isn't fighting just to keep consumers' attention.
While it is also still in the red, SoFi's progress toward profitability is steady, and dependable. Analysts collectively believe it will work its way into the black by 2024, and there's no reason to doubt their earnings consensus trajectory.
Data source: Thomson Reuters. Chart by author. All figures are in millions of dollars.
Bottom line? Don't make this complicated. Robinhood may be creating plenty of noise, but its future is questionable at best. SoFi's isn't, and here's much to be said for certainty when it comes to supporting a stock's price. It's certainly not a great first position for new portfolio, but it is a welcome addition to a diversified portfolio that's already got some defensive, lower-risk holdings in it.
