5 Red Flags for Robinhood Markets' Future

Robinhood Markets' (HOOD -1.81%) stock dipped 3% on April 29 after the online brokerage posted its first quarter numbers. Its revenue plunged 43% year over year to $299 million, which missed analysts' estimates by $59 million. Its net loss narrowed from $1.4 billion to $392 million, or $0.45 per share, but still missed analysts' expectations by a dime.

Robinhood's numbers were ugly, but some investors might be wondering if its stock has finally bottomed out after plunging nearly 75% below its IPO price. Unfortunately, five red flags suggest the pain is far from over.

Image source: Getty Images.

1. Declining MAUs and ARPU

Robinhood's net cumulative funded accounts rose 27% year over year to 22.8 million as its assets under custody (AUC) increased 15% to $93.1 billion. However, its monthly active users (MAUs) dropped 10% to 15.9 million as its average revenue per user (ARPU) plunged 62% to $53.

Those declines, which have persisted over the past year, indicate Robinhood's users are spending a lot less time on the platform as macroeconomic headwinds rattle the equity and cryptocurrency markets.

Data source: Robinhood Markets.

Robinhood didn't provide any top line guidance, but analysts expect its revenue to decline 8% to $1.67 billion for the full year.

2. Investors are retreating from riskier assets

The average Robinhood account is worth just over $4,000, which is tiny compared to the average six-figure accounts at Morgan Stanley's (MS 1.10%) E*Trade and Charles Schwab (SCHW 0.75%).

Robinhood's early success was driven by its pursuit of those lower-income retail investors with commission-free trades. Its streamlined app also made it easier for first-time investors to get started.

However, many of those novice investors chased the hottest trends instead of focusing on longer-term goals. Last year, many of Robinhood's users piled into "meme stocks," their underlying options, and cryptocurrencies. Most of those volatile bubbles popped in recent quarters as rising interest rates and other macro headwinds sparked a retreat from riskier assets.

During the first quarter, Robinhood still generated 58% and 25% of its transaction-based revenues, respectively, from options and cryptocurrency trades. Only 17% came from equity trades.

Last year, Robinhood relied heavily on its growth in options and cryptocurrency trades to offset its slowdown in equity trades. However, all three businesses withered in the first quarter as the markets ran out of steam.

Data source: Robinhood.

3. Crumbling margins and lots of red ink

Robinhood subsidizes its commission-free trades by selling its orders to market makers who squeeze out slim profits from the bid-ask spread. For this payment for order flow (PFOF) model to operate efficiently, it needs its users to actively trade instead of passively sitting on long-term investments.

But when investors shun its platform during a market downturn, the costs of hosting nearly 23 million accounts online will squeeze its margins. Meanwhile, larger competitors like E*Trade and Schwab -- which also offer commission-free trading -- can leverage their scale to pull users away from Robinhood.

As a result, Robinhood's adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) came in at negative $143 million in the first quarter -- compared to positive $115 million a year earlier.

For the full year, analysts expect it to post an adjusted EBITDA loss of $235 million, compared to a positive adjusted EBITDA of $34 million in 2021.

4. Here come the layoffs

That's why it wasn't surprising when Robinhood announced its upcoming layoffs. Between 2019 and 2021, it had increased its headcount from about 700 to nearly 3,800, but it now plans to reduce its headcount by about 9%.

In a blog post, CEO Vlad Tenev said its "rapid headcount growth has led to some duplicate roles and job functions, and more layers and complexity than are optimal." Tenev said the layoffs would improve its operating efficiency, but they also strongly indicate its hypergrowth days are over.

5. Insider selling and lots of dilution

Lastly, Robinhood's insiders sold nearly 400 times as many shares as they bought over the past three months. Its high stock-based compensation (a staggering 74% of its revenues in the first quarter) also caused its number of weighted-average shares to skyrocket 76% since the end of 2021.

That insider selling and aggressive dilution indicate Robinhood's stock still can't be considered a bargain at five times this year's sales -- especially when more promising growth stocks are trading at similar valuations.

Robinhood isn't doomed yet, but it won't disrupt traditional brokerages or become a more diversified fintech platform if it keeps bleeding MAUs. It experienced a major growth spurt during the bull market, but its heavy dependence on active traders, its ugly losses, and its lack of a meaningful moat all make it a risky stock to own in a bear market.