It’s official you can buy Robinhood stock, on Robinhood.

After what seemed like months of breathless media coverage, the digital-first broker everyone loves to hate is now a publicly-traded stock.

In the here and now, Robinhood started out as a disappointment for investors with the stock falling 10% on its first day as a public company.

However, what matters more than stock’s initial debut, is how it performs in the days and weeks that follow.

To help you make the right decision on Robinhood, it’s time to look at how it earned a less than stellar reputation among investors, and more importantly if the fundamentals are improving or falling apart.

Robinhood Robs from the Poor

From its founding in 2013, until mid-2020 Robinhood was building a pretty strong following among younger investors.

The user experience, or UX for short, was second to none and innovations like fractional shares plus option and crypto trading for all, garnered Robinhood a reputation as the broker who cared about the little guy.

Then Gamestop happened…..

Leading up to Gamestop, Robinhood was already under fire for technical glitches on big trading days that effectively locked customers out of buying or selling anything.

Gamestop made things a whole lot worse.

Due to the volatility of Gamestop, the national clearinghouse, “DTC”, made Robinhood put up a lot more cash as a buffer against crazy price moves while the stock trades were in the process of clearing.

DTC asked for more money than Robinhood had, so in an effort not to go bankrupt, Robinhood made a  fateful choice.

First, it negotiated with DTC to put up less cash.

Then it raised the extra money from venture capitalists and hedge funds.

Next, it locked customers out of buying any more Robinhood stock or options, they could only sell.

Robinhood did this to make sure DTC did not ask them to put up even more money which could have put the entire business in jeopardy.

This effectively ended the rally in Gamestop and also handed unnecessary losses to hundreds if not thousands of customers as the price of Gamestop fell back down to earth.

Watch the video below for a more in-depth discussion on how the stock clearing process works and why Robinhood put its needs ahead of investors.

Robinhood customers haven’t forgotten the Gamestop lockout and the company has turned from Robinhood to the Sheriff of Nottingham in the eyes of many.

Who Uses Robinhood

If you are thinking of buying stock in Robinhood, you probably want to know a bit more about the people actually using the platform day in and day out.

Knowing the type of customers and most importantly how large their trading accounts are will help us figuree out the staying power and growth potential of the Robinhood business model.

Do you Know Robinhood?

Future Opportunities – User Experience and Product Access are Second to None

Robinhood is winning over younger investors because the company came at investing with a user experience mindset first, not an investing one.

They wanted to make buying and selling securities as easy as possible, full stop.

Gaining access to options trading, usually a complicated process, is much easier and simpler on Robinhood than anywhere else.

Robinhood also offers crypto trading, including access to obscure coins beyond simply Bitcoin and Ethereum.

The old-school brokers don’t even offer Bitcoin trading yet.

Robinhood is giving customers the investments they want and it doesn’t hurt that trading fees on cutting-edge securities like Doge Coin and Gamestop options are making Robinhood millions.

Future Challenges: The Ad Budget and “PFOF”

The brokerage business is competitive, you can’t just write a blog post about what your company and watch the new customers flood in.

You need to either advertise the old-fashioned way (Online, print or TV) or offer a compelling referral program.

Or, you have the media do all the advertising for you.

Robinhood has been the poster child for the retail investing trend in this bull market and it has done amazing things for the company’s media coverage.

CNBC, CNN, NBC, blogs, Twitter, you name it, they all are talking about Robinhood.

Even though much of the coverage was negative, it got the word out and Robinhood saw a flood of new customers.

Looking at Robinhood’s marketing budget as a percent of revenue we can see how the company basically only spent on refer-a-friend promotions in the past year, and barely a dollar on traditional advertising.

Putting the customer return in perspective, Robinhood spends $15 to acquire a customer, but generates $137 per customer in the first year, a quick 2 month payback.

Robinhood Spent Almost Nothing on Marketing in 2020

Source: Robinhood S-1 Filing

The media coverage won’t last forever, which means investors have to be prepared for marketing costs to go back to normal over time.

If marketing costs go back to normal that would be a $100 million a year hit to cashflow which would essentially eat up all the profits the company is currently generating. They would be back to breakeven, something investors may not be prepared for.

PFOF or Payment for Order Flow

PFOF could also become a huge liability for the company if regulators keep snooping around.

First a primer on PFOF…

Robinhood offers free trading to customers because they are paid by other Brokers to send over all your trades.

The broker makes a small fee for completing your buy or sell, called “the spread” and is willing to pay Robinhood a portion of that fee.

Robinhood will tell you it only sends your trade to the broker who offers the best price.

But in reality, there are question marks on if the broker could be trading against you. The broker can see your order for Apple at the current price, $147, a “market order”.

The broker can then buy Apple stock themselves and sell it to you for a slightly higher price, filling your order.

This is what the industry calls “front running” and is one of the potential issues regulators are looking at with PFOF.

Robinhood generates 80% of revenue from PFOF and would take a big hit if the practice was made illegal or a crackdown tightened the spread, generating fewer fees per trade for Robinhood.

Is Robinhood Cheap or Expensive vs Other Brokers?

The rubber meets the road when we start talking about the value of a stock.

The best lesson you can learn when investing is that even the best company can make a bad investment and vice versa, it all depends on the price you pay.

Robinhood originally planned to go public at $42.00 per share, valuing the company at $35 billion, but ended up settling for $38.00 per share or $33 billion.

This means Robinhood began public life trading for 14x our estimate of 2021 revenue, twice as expensive as your typical old boring brokers like Charles Schwab or TD Ameritrade.

Even if we adjust for the fact that Robinhood is growing much faster than the old guys, the stock is still trading at a 50% premium to all the other brokers as of August 4th.

Like almost every IPO we’ve seen in the last 2 years, you will have to pay up if you want to own Robinhood out of the gate.

Is Robinhood a Buy or Sell?

Love or hate Robinhood, they have built something unique in the investment space.

The key question is can the stock head higher when it is already 2.5x more expensive than other brokers and 50% more expensive if we adjust for the faster revenue growth?

If the bull market continues and bitcoin heads higher we think the stock price can do well.

Robinhood’s fortunes are so closely tied to the rise of the retail trader, we think it would be foolish to bet against this company while DogeCoin remains a top meme, options trading is at decade highs and the market is ill with IPO fever.

However, when the tide turns, Robinhood is going to look like the Sheriff of Nottingham pretty damn quick.

Just as retail traders boost revenues with expensive and risky crypto and options trades, they can easily suffer serious losses on a big YOLO option gone wrong and throw in the towel on their dream to be a day trader.

Robinhood will continue to be a big bull market winner, but if regulators decide to crack down or the stock market loses steam, Robinhood investors will have nowhere to hide.

Stock Broker Revenues need Rising Stock Markets

Source: YCharts

About Author

The opinions provided in this article are those of the author and do not constitute investment advice. Readers should assume that the author and/or employees of Grizzle hold positions in the company or companies mentioned in the article. For more information, please see our Content Disclaimer.