A growth stock is typically defined as a company that is expected to grow at a faster rate than the overall market. When a company's financial metrics consistently move in reverse, it no longer meets the criteria.
That's the case for Robinhood Markets (HOOD -2.63%), which made a name for itself during the pandemic stock market frenzy as the broker to Generation Z. Half its user base entered the financial markets for the first time through the Robinhood platform, so it has played an important role in introducing young people to investing.
But as the pandemic continues to ease and trading activity returns to normal, the company is rapidly shedding active users and revenue. Its stock price has collapsed 88% from its all-time high, and it could get even worse.
Image source: Getty Images.
A shrinking user base
Robinhood reported its financial results for the first quarter of 2022 on April 28, and it revealed a further contraction in the platform's active user base. It marks the third consecutive quarter of user losses, but there's an even more concerning metric: Average revenue per user plunged to $53, the lowest level in at least two years and a whopping 61% below its all-time high.
It's one of the main reasons investment bank Goldman Sachs advised investors to sell Robinhood stock in April. It was a significant call because the bank was the lead underwriter for Robinhood's initial public offering (IPO) in August 2021 and had previously maintained a buy rating.
The Robinhood platform is primarily targeted at retail investors because of its zero-commission fee structure and smartphone app features. These investors typically hold small account balances, and in Q1 2022, Robinhood's assets under custody fell to $93 billion, the lowest level in 12 months.
To stave off some of these issues, the company is investing in building a more comprehensive cryptocurrency business, but there are questions there, too. In Q1, cryptocurrency trading comprised 24% of total transaction revenue, a sharp drop from the 51% it occupied at the height of the 2021 trading frenzy in the second quarter of 2021.
It's becoming clear that the pandemic environment may have marked the peak of trading activity among the retail crowd, and that could be a continuous drag on Robinhood's business.
Mounting losses
Operational woes aren't the end of Robinhood's challenges. The company has been under regulatory scrutiny for the way it earns revenue -- zero commissions doesn't necessarily mean "free," after all. It uses a model called payment for order flow, selling its customers' orders to market makers who fill them at a marked-up price. The Securities and Exchange Commission fined Robinhood $65 million in 2020 for claiming this practice saved its clients money when it actually cost them $34 million more.
The company remains under the microscope for its smartphone app's features, which are said to encourage unnecessary risk-taking.
If Robinhood is made to alter its practices, it could accelerate losses that are already incredibly steep. The company posted a net loss of $392 million in Q1 2022, adding to a $3.6 billion river of red ink that flowed during 2021.
It doesn't help that Robinhood materially missed its revenue estimates for Q1. It previously told the market it could generate up to $340 million for the quarter but ended up delivering just $299 million.
Once an exciting growth stock, Robinhood is proving to investors that its early success may not be replicable. The steep decline in the company's stock might look enticing as a value play, but it's never a good idea to buy shares in a shrinking business. It might be best to wait on the sidelines to see if Robinhood can right the ship.
