The Bulls vs the Bears: Robinhood Markets Inc (NASDAQ: HOOD)

Robinhood Markets Inc (NASDAQ: HOOD) has sure caught the attention of many US investors by making investing more accessible to them…

… and enabling first-time investors to participate in one of the greatest wealth creators of our time — the stock market.

In fact, over 50% of Robinhood customers are new to investing.

Although the online brokerage is unavailable in Singapore, we can partake in Robinhood’s rapid growth since the company is now public after its initial public offering (IPO) at the end of last month.

However, before you get all too bullish about the company…

… let’s look at both the positive and negative aspects of Robinhood to make a more well-informed decision before investing in its shares.

Why You Should Buy Robinhood Shares (The Bull Case)

Strong Customer Base Leading to Profitability

Robinhood’s business has been a beneficiary of the COVID-19 pandemic.

With stay-at-home orders handing more time to investors and the stock market rebounding strongly since hitting a bottom in March 2020, the zero-commission broker saw substantial growth in its customer base, retention, engagement and trading activity metrics.

For instance, Robinhood’s monthly active users (MAU) surged over 170%, from 4.3 million in 2019 to 11.7 million in 2020.

The MAU figure shows the number of unique users who make a debit card transaction, move between two different screens on a mobile device, or load a page on a web browser.

MAU is a measure of user engagement on the Robinhood platform and is positively correlated with revenue.

The growth in MAU was partly fuelled by Robinhood’s referral program, similar to what moomoo and Tiger Brokers offer here in Singapore.

Existing users are incentivised to invite their family and friends to join Robinhood under the Robinhood Referral Program. Both the new user and existing customer stand to get a free stock.

Last year, over 80% of newly funded accounts joined the Robinhood platform organically or through the referral program, decreasing the marketing costs for the company.

With the strong growth in customers and higher trading activity, Robinhood’s total revenue grew for 2020, ballooning 245% to US$958.8 million, up from US$277.5 million a year back.

The surge in revenue helped Robinhood turn a profit for the year, compared to a net loss of US$106.6 million in 2019.

International Growth and More

Robinhood still has plenty of room to grow. For one, the US retail investor market is far from mature.

Retail investing roughly takes up 20% of the US equity trading volume now. Even though this has doubled from the last decade, Robinhood believes there’s still significant room for growth.

According to Pew Research, around 60% of Americans still do not have investments outside their retirement accounts.

And a 2020 Gallup poll showed that 68% of young adults aged 18 to 29 are not invested in the stock market.

As more and more people become educated on the merits of investing, Robinhood could see higher uptake of its services.

Robinhood doesn’t only provide stockbroking services but also allows cryptocurrency trading.

Robinhood’s cryptocurrency trading platform offers commission-free buying and selling of cryptocurrency, giving established crypto exchanges like Binance and Coinbase (which charge fees) a run for their money.

If there’s increased adoption of cryptocurrency trading overall and continued growth of use cases for crypto-assets, Robinhood stands to benefit as well.

Currently, Robinhood doesn’t offer its services outside of the US. However, the company believes there’s a huge opportunity for it to grow internationally.

According to Credit Suisse Research Institute, as of mid-2019, total global wealth outside of the US was estimated to be over US$250 trillion.

That’s a large market that Robinhood can tap into, considering its assets under custody was just around US$63 billion at the end-2020, and this came from the US alone.

Over time, Robinhood plans to expand overseas, including into Europe and Asia.

Founder-Led Company with High Insider Ownership

Robinhood was started in 2013 by two co-founders, Vladimir Tenev and Baiju Bhatt.

The founders believe everyone should have access to the financial system, and that has led to Robinhood’s mission statement, which is to democratise finance for all.

Together, the co-founders own around 65% of the company. The high insider ownership should align their interests with that of Robinhood’s minority shareholders.

If Robinhood does its business well and right over the long run, it can continue achieving new heights.

Why You Should Think Twice Before Buying Robinhood Shares (The Bear Case)

However, as with all companies, there are risks to consider.

Here are some things investors should ponder about before ploughing their hard-earned money into Robinhood’s stock.

Revenue Concentration Risk

Robinhood pioneered commission-free trading with no account minimums.

Contrary to traditional brokers that make money via fixed trading commissions, Robinhood makes money from market makers in what is called “payment for order flow”, or PFOF.

In simple terms, PFOF involves Robinhood sending its clients’ market orders to third-party market makers, who execute them and earn fees for doing so, with a portion going to Robinhood as payment for routing the customer’s order to the market maker.

The payment Robinhood receives is typically based on a fixed percentage of the difference between a stock’s bid and ask prices at the time of trade.

Robinhood claims that its routing system is designed to automatically prioritise routing customer orders to a market maker that’s likely to give clients the best execution, based on historical performance.

And that it doesn’t route orders based on the rebate it gets.

But Robinhood’s PFOF practice has courted controversy.

In December 2020, Robinhood paid a US$65 million settlement to the US Securities and Exchange Commission (SEC) after the regulator found that its PFOF model had deprived customers of US$34.1 million, caused by inferior order pricing.

This means that customers had, in fact, been indirectly paying commission to Robinhood.

No wonder Charlie Munger said the following about Robinhood’s “free” trades during the Daily Journal Corporation‘s annual general meeting held earlier this year:

“Well, Robinhood trades are not free. When you pay for order flow, you’re probably charging your customers more and pretending to be free. It’s a very dishonorable low grade way to talk. And nobody should believe that Robinhood trades are free.”

(There’s no such thing as free lunch after all, eh?)

For the three months ended 31 March 2021, transaction-based revenues (which PFOF is part of) represented 81% of Robinhood’s total revenue.

And of the 2021 first-quarter revenue, 59% came from just four market makers.

Robinhood’s transaction-based revenue model could be harmed significantly if the PFOF model is barred by regulators.

With the PFOF arrangements not documented under binding contracts, Robinhood’s transaction-based revenue could also be impacted negatively if any of the market makers part ways with the company.

Robinhood shareholders are concerned about PFOF as well, as seen from the company’s question-and-answer session.

The question above was one of the most top-voted questions amongst many others.

Unsure of Revenue Growth Sustainability

As seen earlier, Robinhood saw significant business growth last year for various reasons, including the stock market boom that started at the end of March 2020.

I’m not sure how sustainable that revenue growth will be going forward since a significant number of new accounts opened in the first half of 2020 were by first-time investors.

Many Robinhood customers could have jumped onto the stock market bandwagon out of FOMO (fear of missing out).

History has shown that the stock market corrects quite frequently. Since 1950, the US’ S&P 500 index has declined at least 10%, on average, every 1.87 years.

When the stock market does a steep correction or crashes again, and if Robinhood’s new clients panic and pull their money out en-masse, the company’s revenue could be hit badly.

In fact, Robinhood said in its IPO prospectus that the “circumstances that have accelerated the growth of our business may not continue in the future”…

… and that it expects the growth rates in revenue, MAU, and other key metrics to decline in future periods, and such declines could be significant.

Robinhood’s Brand and Reputation Hit

Earlier this year, Robinhood temporarily prevented its customers from purchasing certain company stocks, including Gamestop and AMC.

The move resulted in negative media attention, customer dissatisfaction, litigation, and US Congressional inquiries, among other things.

There were over 120,000 tweets in just two days from Robinhood users venting about the situation via hashtags such as #boycottrobinhood, #deleterobinhood, and #cancelrobinhood.

With the meme stock saga, we have seen how strong the online community (especially Reddit) can be and how it can move complete strangers to act collectively.

If Robinhood gets a bad rap from its users again and they indeed boycott its platform, Robinhood’s business could be impacted severely.

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Disclaimer: The information provided by Seedly serves as an educational piece and is not intended to be personalised investment advice. ​Readers should always do their own due diligence and consider their financial goals before investing in any stock. The writer doesn’t own shares in any companies mentioned.