Robinhood Markets (HOOD -0.55%) caught lightning in a bottle during 2020 and 2021, when the pandemic placed the U.S. population under lockdowns and put federal stimulus money into people's pockets. Its easy-to-use investment platform resonated with Gen Z, which was entering the stock market for the first time with an appetite for short-term gains.
But that environment was never going to last, and Robinhood experienced a significant deterioration in its business as life gradually returned to normal.
But the company continues to innovate and it just introduced 24-hour trading that will enable users to buy certain stocks outside of regular market hours. While that's a cool feature, here's why Robinhood needs to do much more to persuade me to buy its stock.
Image source: Getty Images.
New features might not be enough
Robinhood's current strategy is to create innovative products to expand its addressable market, which it hopes will attract new customers. It launched cryptocurrency trading in 2018, a cash debit card in 2022, and a high-interest cash account earlier this year. But its new 24 Hour Market might be its most creative project so far. It will let customers place limit orders for 43 of the largest U.S. stocks and exchange-traded funds 24 hours a day, five days a week -- even when the stock market is closed.
But so far, none of those products have delivered sustained user growth. In the middle of 2021, Robinhood had 21.3 million customers interacting with its platform every single month. Fast-forward to the first quarter of 2023, and the company now averages just 11.8 million monthly active users.
That had a series of knock-on effects, including a steep drop in the company's assets under custody (AUC), which is the value of all the cash, stock, and other financial assets held by customers on Robinhood's platform. It came in at $78 billion in Q1, which is well below its peak of $102 billion two years ago. But on a positive note, it marked an increase from last year's low of $62 billion, mainly because the stock market kicked off 2023 with a rebound, lifting the value of customers' portfolios.
Most of Robinhood's revenue is transaction-based, and comes from processing trades under its payment for order flow model. When the value of its AUC declines, it lowers the company's ability to earn fees because volumes (in dollar terms) are inherently lower.
Robinhood's revenue growth lacks momentum
At face value, Robinhood's revenue actually soared 47% year over year in the first quarter of 2023. But the devil is in the details, and its transaction revenue -- the company's bread and butter -- declined by 5%. So what drove the overall increase?
The U.S. Federal Reserve has aggressively hiked interest rates during the past 12 months, which means cash accounts at banks are paying a respectable yield for the first time in years. Since Robinhood's customers held about $3 billion in cash on its platform in Q1 (which is actually held with Robinhood's banking partners), combined with the company's own $6.3 billion in cash on its balance sheet, it earned a substantial amount of interest on those deposits.
Plus, Robinhood also lends money to customers to buy financial securities (this is called margin lending), so it earns interest there, too.
The above factors combined sent the company's net interest revenue soaring 278% year over year in Q1, which was more than enough to lift its overall revenue higher despite its transaction revenue declining.
The problem is, most investors don't expect interest rates to remain at current levels for long. According to the CME Group's Fed Watch Tracker, there's an 80% chance the Fed will begin to cut interest rates as soon as September. As a result, Robinhood's revenue could soon contract again, as it did most of last year.
Investors aren't very optimistic about Robinhood's prospects
I mentioned above that Robinhood has about $6.3 billion in cash and equivalents on its balance sheet. However, at its current share price of $8.38, investors are valuing the company at just $7.5 billion -- so after stripping out its cash, they're effectively saying Robinhood's actual business is valued at only about $1.2 billion.
Part of the reason is the company's net losses. Robinhood burned over $1 billion at the bottom line in 2022, and it had a net loss of $511 million in the first quarter of 2023, although that included a one-time nonrecurring charge of $485 million. It has made an effort to bring down costs, and successfully shrank its operating expenses by 25% in Q1, which is a positive sign.
But without a sustained increase in active users and transaction revenue, Robinhood will be fighting an uphill battle to reach profitability. If the company's transaction revenue is lower a year from now, it will have to cut expenses even further, leading to a smaller business to which investors attribute an even lesser value.
At this stage, no matter what features Robinhood releases, I need to see them having a real impact on the company's core financial metrics before I buy the stock. I'm avoiding it until then, no matter what time of the day it lets me buy it.
