Opinion: You shouldn’t buy Robinhood shares without first knowing these 10 pros and cons

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Robinhood goes public. Should we buy the share?

This is particularly relevant for HOOD from Robinhood Markets Inc.,

18 million users, including me, as the app-driven discount brokerage firm will lead us up to 35% of the initial public offering (IPO).

Here are the main advantages and disadvantages. The IPO will likely take place the week of July 26, according to Renaissance Capital. We’ll learn more at this point about the missing piece of the puzzle: the price of the IPO.

Let’s start with the six positives. While Robinhood is controversial, it’s clearly a great company.

Lily: The five most striking disclosures from Robinhood’s IPO filing

1. Growth is rapid

Robinhood’s PR disasters – a trading platform frozen during critical times, a record regulatory fine – haven’t killed user growth. It’s explosive. Last year, accounts grew 143% to 12.5 million, and revenue increased 245%. This continued into the first quarter, when accounts rose 151% to $ 18 million and revenue jumped 309% year-over-year.

“What strikes me is their growth. and the fact that clients are first-time investors, ”says Matthew Kennedy, senior strategist at Renaissance Capital, which manages the Renaissance IPO ETF IPO exchange-traded fund,
-0.14%.
New investors are likely to stay with the brokerage for a long time.

Of course, growth will slow down. But the momentum will continue, and there is plenty of room for more. Competitor Charles Schwab SCHW,
-2.24%
estimates that US investors have $ 50 trillion in investment accounts. Robinhood has $ 81 billion in client assets.

2. Robinhood has built a powerful brand

The company has been the victim of platform failures, promoting the “gamification” of investing and restricting stock trading even like AMC Entertainment AMC,
-9.30%
and GameStop GME,
-2.46%.
This has led to lawsuits and fines. But the public has short memories, and the statistics confirm the power of the Robinhood brand and the sympathy of its platform.

Over 80% of new accounts come from referrals from clients or people signing up on their own, ad-free. (Robinhood calls this growth “organic.”) Almost half of all new retail accounts opened in the United States from 2016 to 2021 were on Robinhood. It is quite amazing. Brands are essential in retail businesses with direct contact with customers, especially when they lead to defensive ditches.

3. The company is managed by its founder

University studies and my own experience as an investor confirm that companies run by founders outperform. This is one of the key qualities I look for when suggesting companies in my stock letter, Brush Up on Stocks (the link to the letter is in my bio, below). The founders of the company, including Jeff Bezos at Amazon.com AMZN,
+ 0.84%
and Elon Musk at Tesla TSLA,
+ 0.08%
are motivated by more than money. They have a passion for business development. This is the type of manager you are looking for in your investment portfolio. Robinhood was founded in 2013 by Vladimir Tenev and Baiju Bhatt, who are now CEOs and Creative Director.

4. Profit margins could be significant

In part because its brand and platform attracts low-cost customers, the company’s profit margins could be significant. Robinhood’s main source of revenue is order flow payment – routing trades to market platforms, including Citadel – and the costs are low. “There aren’t a lot of revenue costs here,” Kennedy says. “Paying for order flow is inherently a high-margin business. “

5. There is plenty of room to grow

Robinhood has a development and expansion strategy. It lands in the lives of young people – people who are just starting their financial lives. As they progress and demand more products, Robinhood will provide them and extract more revenue per customer. “They have a number of young and very enthusiastic clients, and they will need new services such as auto loans, credit cards, mortgages and retirement counseling,” says James Angel, professor of finance. at the McDonough School of Business at Georgetown University. These markets are huge. Credit card purchases in the United States were worth $ 3.6 trillion last year, and peer-to-peer payments totaled $ 4 trillion, according to Square SQ,
-0.79%.
Robinhood also has room to expand into Europe and Asia.

6. Leaders are free to think long term

Robinhood likes to boast that its mission is to “democratize finance for all”. It is therefore ironic that the company is anything but democratic. It has created special share classes which concentrate the right to vote in the hands of a few people. It sounds terrible. It is “undemocratic”.

But here’s a little secret: it can be a big plus for investors. Listen to me. By removing the threat of disgruntled outsiders gaining board seats, Robinhood gains the freedom to “annoy” short-term investors by sacrificing short-term profits to invest profits in the business. It gives management the incredibly valuable freedom to think long term and make better decisions. Many of the top performing companies have used this quality to their advantage, including Facebook FB,
-0.06%,
Amazon.com and GOOGL Alphabet,
+1.82%.

Robinhood investors will face serious risks. Here is an overview.

1. Regulators crack down

Politicians and regulators are concerned about the ease with which Robinhood has allowed customers to interact with the market. Critics describe it as “gamification”. The user-friendly nature of its app opens the door to this. Regulators are concerned that this may promote behavior – such as excessive trading – that is not in the best interests of customers.

The Financial Sector Regulatory Authority (FINRA) has already fined Robinhood $ 70 million, in part for failing to properly screen clients before approving them for options trading and margin accounts, or for having correctly explained the risks. The Securities and Exchange Commission (SEC) fined Robinhood $ 65 million after accusing the company of deceptive clients about how the app makes money and failed to complete trades the best. Massachusetts regulators are attacking the company, accusing it of predatory marketing to inexperienced investors.

“Very clearly, the SEC and FINRA are looking at the user interface,” says William Mann, director of small-cap research at The Motley Fool. “At some point there will be a critical mass of individual investors who suffer enough losses that regulators will be forced to act and put limits on the strategies Robinhood uses to make trading exciting. We are in a social brokerage crisis, far from being much more important for the SEC and FINRA. “

Then about 80% of Robinhood’s $ 522 million in overall Q1 revenue came from order flow payment, which means selling transactions to third parties. SEC Chairman Gary Gensler argues that this could create a conflict of interest with a broker’s responsibility to provide best execution. If regulators stop this or restrict it in some way, that will be a challenge for Robinhood. Robinhood is also facing private lawsuits for platform failures.

2. Crypto explodes

Regulators around the world could crack down on cryptocurrencies due to their use by criminals. Central banks do not like competition in the creation of money supply. The crackdown would be a problem for Robinhood since it earned 17% of its $ 420 million in transaction-based income in the first quarter of crypto trading, Kennedy points out at Renaissance Capital.

3. The retail boom is fading

“The boom in retail is clearly benefiting them, and we don’t know how stable that is,” Kennedy warns. “A lot of their traders made money. Meme stocks performed well, as did crypto. But if the returns disappear, you will see that income dry up, ”he says. Robinhood can be particularly vulnerable among brokerage houses because it earns so much income from risky options trading, around 38% in the first quarter. “Traditional brokerages have a lower percentage of income from options and crypto. If you have a huge market downturn, all of that trading could dry up pretty easily. “

4. A bear market destroys income

Is Robinhood “calling” the top of the market with its IPO? It’s possible, and Robinhood wouldn’t be the only company to do so. The first quarter was the largest period of IPOs ($ 40.7 billion in gross proceeds in the United States) since the last quarter of 1999, says Kennedy at Renaissance Capital. The great technological crash followed in 2000.

The bottom line: You have to remember that companies choose when to go public. So guess what? They do it when it’s convenient for them, not you, the investor. The current IPO frenzy suggests the S&P 500 SPX,
+ 0.45%,
Nasdaq COMP,
+ 0.48%
and the Dow Jones Industrial Average DJIA,
+ 0.29%
could be at the top or near a top. “There are a lot of sparkling products coming into the market,” says Angel, in Georgetown. Market-related companies such as brokerage houses and fund management companies are severely affected by bear markets. It will happen, sooner or later, and Robinhood will see a sharp drop in payments for order flow and customer growth.

Michael Brush is a columnist for MarketWatch. At the time of publication, he had no position in the stocks mentioned in this column. Brush suggested SCHW, FB, AMZN and GOOGL in their stocks newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks.


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