A couple of years ago the stock market experienced something seemingly out of a movie. A number of social media personalities began to emerge and garner the attention of the masses as people sat at home working remotely.
In the finance community, perhaps the most infamous of these online influencers was Keith Gill, otherwise known as Roaring Kitty. Gill was at the nucleus of the GameStop short squeeze. But on the other side of the equation was a little-known trading app called Robinhood Markets (HOOD 4.44%).
Robinhood found itself as one of the villains during this saga due to a number of questionable decisions by management -- namely, restricting trading in particularly volatile securities. Yet despite some turbulence in public relations, Robinhood has come a long way in the last couple of years.
Here's why I believe Robinhood is undervalued and could be an interesting stock to buy right now.
Celebrating a big milestone
When analyzing a company's financial statements it can be easy to get caught up in a bowl of "number salad." For Robinhood, I would like to bring focus to two areas in particular: revenue and profits.
Robinhood primarily generates revenue from transaction fees as well as interest from things like cash and securities lending. Given the hype in the stock market during 2021 and the first half of 2022 it is not entirely surprising to see that the bulk of historical revenue stemmed from transaction fees. However, given the current environment of high interest rates, the dynamic has switched. Robinhood's revenue profile has been dominated by interest fees so far in 2023.
Image source: Robinhood Q2 2023 investor presentation.
Although the company's revenue mix is not immune to macro conditions, management has done a stellar job navigating the business through the current economic climate. For me, the most exciting financial metric from the second-quarter report, released Aug. 2, was Robinhood's positive generally accepted accounting principles (GAAP) net income of $25 million. This marked the first time as a public company that Robinhood was net income positive.
Image source: Robinhood Q2 2023 investor presentation.
How is Wall Street reacting?
One of the most followed investors on Wall Street is Ark Invest CEO Cathie Wood. As I've written previously, part of Wood's conviction around Robinhood is the company's roadmap to become a "digital wallet."
In essence, what began as a simple stock trading app has quickly evolved into an ecosystem that offers users the ability to buy and sell other assets such as cryptocurrencies and options. Furthermore, Robinhood also offers a number of traditional banking services such as IRA retirement products and cash rewards cards.
Wood has been buying Robinhood stock for a couple of years, notably adding to her position when the stock was falling from highs in late 2021. More recently, over the last two months Wood has bought approximately 2.6 million shares since the end of June.
But Wood is not the only bull on Wall Street for Robinhood. Over the last two weeks research analysts from Keybanc and Mizuho raised their price targets to $14 and $15, respectively, while Morgan Stanley maintained its $13 price target. These estimates imply up to 44% upside from current trading levels.
Image source: Getty Images.
The value is hard to pass up
When it comes to valuation, benchmarking a stock against a set of cohorts is a useful exercise. The charts below emphasize free cash flow among Robinhood and its competition.
HOOD Free Cash Flow data by YCharts
Investors can see that among these fintech names, Robinhood and Interactive Brokers are the only two that are generating positive free cash flow. Yet despite this disparity, Coinbase Global trades at the highest market capitalization, and SoFi Technologies is not too far behind Robinhood and Interactive Brokers. The premium that Coinbase stock is fetching is interesting when you consider that Wall Street believes the crypto giant is losing market share to Robinhood.
When assessing the data above, I believe that Robinhood is undervalued. The company appears to have turned a corner as evidenced by its focus on sustained profitability. Moreover, management has shown a commitment to shareholders to beef up the platform and differentiate among other neobanks and digital wallets.
While Robinhood still has a lot to prove, the stock is hard to pass up when you compare it against its peers. A prudent strategy could be to dollar-cost average into the stock over time. Should the company further separate itself from other digital banks and trading platforms in the form of more meaningful cash-flow generation, it could be worth doubling down on in the long run.
