Robinhood (NASDAQ: HOOD) faced a disappointing first day as a public company, with its share price falling over 8% from its IPO price of $38. This was mainly due to concerns over the company’s high valuation and the risks of regulators intervening. Even so, Robinhood has seen its popularity explode since its foundation in 2013, and there is significant growth potential. As such, should I be buying Robinhood shares after this disappointing IPO, or are they far too risky?
Robinhood states that it wants to “democratize finance for all”. This means that since 2013, it has offered retail investors commission-free trading of stocks, funds, cryptocurrencies and more. And this has proved extremely popular. Indeed, the company now boasts over 18m customers, and claims that half of new investors in the US since 2016 have chosen Robinhood.
Revenues have also grown dramatically, and in the first three months of 2021, they were $420m. This is over a 300% increase in just a year. Although it expects to be unprofitable over the next few years, Robinhood was also able to make a very small profit of $7m in 2020. This demonstrates to me that there is a route to profitability for this firm, and that distinguishes it from many other tech stocks. This is one factor that could tempt me to buy Robinhood shares.
As Robinhood is commission-free, it makes the majority of its revenues (over three-quarters) from payments for order flow (PFOF). This means that it processes orders from its customers, before passing them on to a market maker. It will then receive a very small fee as compensation for doing this.
But there are issues with this. Indeed, Gary Gensler, the SEC Chair, has recently raised concerns about PFOF at the start of June, and intends to conduct a review of the system. This could lead to a regulatory crackdown, which would surely have a negative effect on the Robinhood share price.
I am also concerned that Robinhood has faced legal issues in the past, including a $70m fine from the Financial Industry Regulatory Authority in the US this year. This was because “the firm [had] negligently communicated false and misleading information to its customers”. Although Robinhood states that it has invested heavily in improving this side of the business, I am still concerned.
Finally, I am worried that revenues are not entirely safe. For example, in the first quarter of 2021, 6% of revenues were generated from investors trading Dogecoin, a ‘joke’ cryptocurrency. Due to the status of the cryptocurrency, alongside potential regulatory scrutiny of cryptocurrencies in general, I cannot see such revenues being sustainable. As such, it will be crucial for Robinhood to find new sources of revenues, and this may prove hard.
Am I buying Robinhood shares?
The short answer is, no! There are far too many risks, and while I am impressed at its incredible ascendency, a valuation of over $30bn still seems too high. As such, I think there are far better options out there.
The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of investment advice. Bitcoin and other cryptocurrencies are highly speculative and volatile assets, which carry several risks, including the total loss of any monies invested. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
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Stuart Blair has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.