Robinhood Markets (HOOD 4.44%) just reported its financial results for the second quarter of 2023. It joins a slew of important technology companies updating investors on their progress in this tough economic environment, and while some have beaten expectations, others have disappointed.
Robinhood falls in the latter category, except the economy can't really be blamed for its present situation. The user base on its investing platform -- which is popular with young investors -- continues to shrink, and any revenue growth the company generates is due mostly to high interest rates, which aren't expected to last.
Robinhood's stock price sank 7% following the release of its results, and it's now down 86% from its all-time high set all the way back in 2021. Here's why I still wouldn't consider buying this stock.
Robinhood is struggling to acquire new customers, and old ones aren't staying
2021 was a bumper year for Robinhood. The pandemic placed consumers under strict social restrictions, and the U.S. government flooded the economy with stimulus, so scores of young people decided to take their cash and experiment in the financial markets. They found a home on Robinhood's platform, which delivered a mobile-first, gamified user experience that made it easy for new investors to buy and sell everything from stocks to cryptocurrencies.
By the second quarter of 2021, about 22.5 million customers had signed up and funded an account with Robinhood, and 21.3 million of them were active on the platform every month. But in the two years since then, the company has only added 700,000 new funded accounts, and only 10.8 million of them were active each month in the second quarter of 2023.
That's a 49% decline in its active user base, and it's showing no signs of recovering.
On a positive note, Robinhood's assets under custody, which account for all the cash and financial assets the platform is holding on behalf of customers, did jump 38% year over year in Q2 to $89 billion. But most of that increase was attributable to a broad rise in the value of customers' stock portfolios following a brutal sell-off in 2022 rather than new cash deposits.
Robinhood's revenue surged 53% in Q2, but there's more to the story
Robinhood earns revenue in two main ways. It earns transaction revenue which comes from customers buying and selling financial securities on its platform. It also earns interest revenue because it stores its cash -- and customers' cash -- in banks.
Transaction revenue is the most important for Robinhood because it stems from the company's operations. If Robinhood is growing its business and customers are actively investing on its platform, it should earn more transaction revenue over time.
Robinhood's total revenue soared by 53% year over year in Q2, which was a fantastic result at face value. But beneath the surface, its transaction revenue actually declined by 4%. The overwhelming majority of its overall revenue growth came from interest revenue, which tripled compared to the same period last year.
In 2022, the U.S. Federal Reserve embarked on the most aggressive campaign to hike interest rates in its history to fight inflation. Since Robinhood has over $6.3 billion of its own cash on its balance sheet, plus the $3 billion it's holding for customers, it's earning a substantial amount of interest revenue thanks to rising rates. In fact, it has earned more interest revenue than transaction revenue in 2023 overall.
That's a problem for the future of Robinhood's business
Interest rates are unlikely to remain at current levels forever. Many economists believe the Fed will begin to lower them in early 2024, which will deal a blow to Robinhood's revenue base. It would also mean the company will be forced to rely on growing its transaction revenue, which is going to be extremely difficult if its active user base continues to shrink.
Robinhood is valued at just $10.5 billion as of this writing, following the 86% decline in its stock price over the last two years. But given that there is over $6.3 billion in cash on its balance sheet, investors are really saying the actual business is worth just $4.2 billion. In other words, Robinhood's platform, all of its technology, and its customer base are worth less than its cash on hand!
Investors vote with their wallets, and they don't seem to believe Robinhood will be capable of mounting a meaningful recovery from this operational slump. I tend to agree, so I wouldn't buy Robinhood stock if you gave me free money.
