Financial services company Robinhood Markets (HOOD 5.77%) has become one of Wall Street's better-known stock brokerages. It built a reputation on innovation as the first brokerage to offer commission-free trading. During the 2020-2021 meme stock craze, it gained notoriety when technical malfunctions disrupted trading for its account holders.
Although the stock trades at about 50% below its 2021 peak, its price has risen by more than 70% in the past year alone.
Investors who believe Robinhood will continue to carve out an increasingly larger share of the retail investment industry have a buying opportunity. But before you buy shares, consider these four observations that could impact your investment thesis.
1. Robinhood's user count is growing
Robinhood has never shied away from getting aggressive to acquire users. Its commission-free trades disrupted the brokerage industry's status quo and became the new normal for investors. Robinhood has kept its foot on the gas, tinkering with promotions such as making matching pledges on deposits and retirement account contributions and announcing a 3% cash-back credit card.
The incentives are working. As of February, Robinhood had 23.6 million funded accounts, a 550,000 user account increase year over year, and a 130,000 account increase over the prior month. Whether it can maintain that momentum remains to be seen, but it's a positive sign for long-term shareholders.
2. Account value among Robinhood users is improving
Investor reluctance to park big money in Robinhood is one of the platform's longest-standing challenges. Its association with meme stocks has seemingly attracted "fun money" but turned off investors from putting large balances on the platform. Robinhood has tried to correct this with incentives, specifically, its 3% match on IRA contributions.
Today, Robinhood has $118.7 billion in assets under custody, spread across 23.6 million accounts, an average of $5,029 per account. This is an improvement from January 2023, when it had $74.7 billion across 23 million accounts, an average of $3,247 per account. However, it will need to continue growing those metrics over time. Higher deposits provide it with more net interest income.
3. Robinhood benefits from higher interest rates
Investors need to watch Robinhood's profitability, not only because earnings ultimately drive share prices but also because the business could struggle to continue funding its aggressive customer-acquisition incentives if it is bleeding money to do so. Robinhood makes money from three different avenues:
- Order flow (it captures a small spread on each trade users make).
- Subscriptions (Robinhood Gold).
- Net interest (investment income minus interest paid on deposits).
In 2022, the Federal Open Market Committee began its effort to bring soaring inflation back in check, and as a major part of that effort, it rapidly and steadily increased the benchmark federal funds rate. This pushed interest rates higher across the economy, and those higher rates have given Robinhood more room to make money on interest. In Q4, net interest (interest received minus interest paid to depositors) accounted for $167 million of Robinhood's $380 million in revenue. That illustrates just how critical interest is to Robinhood -- and it becomes even more obvious considering its earnings were only $30 million in Q4.
Ideally, it won't always be like this as the company develops and grows other revenue streams. But right now, higher rates are providing a major benefit to Robinhood, and the declining interest rates that many market watchers anticipate are coming could spell trouble for it.
4. Robinhood is still battling with image problems
Robinhood faced backlash during the famous Gamestop short squeeze in 2021. The stock's extreme volatility caused Robinhood to restrict trading and temporarily prevent some users from transferring assets out of the platform. Later, CEO Vladimir Tenev was called before U.S. lawmakers to testify about the sequence of events.
The platform appears to be grappling with the image problems that originated during the Gamestop crisis. Polling on social media and comments among users on the social media site Reddit suggest users remain concerned about trust in the platform. This ultimately impairs its ability to convince users to put large sums in their Robinhood accounts.
Not a short-term holding
Valuing this stock is challenging because Robinhood derives so much of its revenue from volatile sources. How frequently users trade and where interest rates go next will significantly impact its most important revenue streams. The good news is that the company has over $8 billion in cash and short-term investments on its books, so it has plenty of money to fund growth while it works toward a more diverse and predictable business model.
Trading at a price-to-book value over 2, shares aren't as cheap as they were 12 months ago. Investors considering buying the shares today should look at Robinhood as a long-term pick. The stock's eventual success or failure will ultimately depend on whether the platform can win over users and client assets, especially among higher-net-worth individuals.
