Robinhood Stock: A Terrible Business Model Not Worth Investing In

LorenzoT81

Founded in 2013, Robinhood (NASDAQ: HOOD) is a financial services platform whose mission is to democratize finance for all. The company was one of the first to introduce commission-free stock trading, accessible from mobile devices, and has further expanded its product offering from stocks to crypto and, most recently, a payment card.

Robinhood’s products can be divided into four main categories: Investing Solutions, Robinhood Crypto, Robinhood Gold and Cash Management.

Investing Solutions allows clients to invest commission-free in US-listed stocks, ETFs, options and ADRs from their smartphone. The user interface is designed to be easy to understand, with the aim of making investing less daunting and more accessible to individuals. Through the Robinhood app, users can invest in fractional shares, set up recurring investments, and access initial public offerings at an IPO price.

Robinhood Crypto is its commission-free cryptocurrency trading product, which uses the same user-friendly interface as its investment solutions. The company has continued to invest heavily in its crypto offerings through 2022, with the addition of crypto wallets, the launch of new coins, and the planned integration with the Bitcoin Lightning Network.

Robinhood rolls out new crypto products

Robinhood Investor Presentation Q1’22

Robinhood Gold is a premium subscription service with a fixed monthly fee. Gold subscribers can enjoy enhanced instant access to filings, unlimited access to professional research through Morningstar, access to margin investing, and the ability to see more data on a stock or option given via Nasdaq level II market data.

Finally, the cash management product allows customers to earn interest on idle cash in their Robinhood brokerage account through banking partners. There is an additional option to spend money via a Robinhood-branded Mastercard debit card.

Robinhood payment card

Robinhood Investor Presentation Q1’22

Robinhood’s name is taken from the English stories of a man who robs the rich to give to the poor – as the company seeks to open up investing not just to the wealthy on Wall Street, but to anyone. It’s a big mission for a company, but in my opinion it was very poorly executed.

A broken business model

The majority of Robinhood’s revenue is transaction-based, despite the company’s marketing of being commission-free – they take a order flow payment fees when it comes to buying and selling stocks or options. The company also generates similar fee-based revenue from all cryptocurrency transactions. In 2021, transaction-based revenue made up 77% of total revenue, with net interest income representing 14%.

Net interest income comes from stock lending as well as holding collateral for margin loans that Robinhood extends to its users. The company also earns interest income from margin loans to users, but more on that later…

Robinhood quarterly revenue broken down by type

Robinhood/Excel SEC Filings

Clearly, transaction-based revenue is the biggest source of revenue for Robinhood, but what makes the majority of that money? Well, the breakdown below doesn’t hurt a pretty picture.

Revenue distribution based on Robinhood transactions

Robinhood/Excel SEC Filings

One of the big issues here is that growth has clearly hit a huge wall. Robinhood has benefited significantly from lockdowns (as fewer people have been able to go to work and end up trading) as well as a booming stock market in 2020 and 2021. We can see that clear-as-day spike in their earnings, but that’s It has since collapsed down to earth, with Q1’22 transaction-based revenue down nearly 50% year-over-year.

I’m all for the democratization of finance, but the problem for Robinhood is that stock trading just doesn’t make as much money as some other products. The first thing that jumps out in the chart above is crypto’s huge spike in Q2’21, but anyone who has followed cryptocurrency knows that its trading is very cyclical. There are times when everyone is talking about crypto as prices skyrocket and more and more people are rushing to try and make some money. This translates to a huge spike in revenue for Robinhood (as we can see in Q2’21), but this level of revenue cannot be consistently relied upon (as seen in every other quarter).

Bitcoin Price Chart
Data by YCharts

Next, we’ll look at options, which are clearly the main revenue generator for Robinhood. The problem that Robinhood has faced is that it has a history of offering overly complex products to users – and overly complex financial products that are available with limited checks can lead to many hardships for individuals.

Profits made through risky offers

Not only does Robinhood offer its users complex financial products, but this, combined with the ability to trade on margin, can lead to huge blowouts. There are many stories of people who lost a ton of money on Robinhood, and tragically one user who committed suicide in 2020 after using options despite his lack of financial experience, after which he mistakenly received a notification that he had a negative balance of $700,000 in his account.

The company also came under fire after shutting down trading in some “meme stocks” following the GameStop craze in 2021, which then landed the company in hot water with the government.

The problem here is that Robinhood’s business model relies on complex financial products and speculative cryptocurrency. In my view, the only sustainable business model is to find a way to extract value from the buy-and-hold style of equity investors because they will stay on the platform much longer. But this business model is very similar to traditional brokers.

Robinhood makes most of its money when trades are made – so they will do extremely well during times when the stock market is hot, when meme stocks go to the moon, and when you can buy a Tesla with Dogecoin. But, in a world where a recession is looming, inflation is out of control, and money isn’t being thrown around like in 2021, Robinhood’s business model is in trouble, in my opinion.

User growth plummets

As more people return to work and are no longer stuck indoors, it’s no surprise to see Robinhood hemorrhaging active users. It is also possible because the majority of retail traders lose money long term, so I doubt many of them will stay on the platform. We can see that Robinhood’s monthly active users are moving in the wrong direction.

Robinhood Monthly Active Users

Robinhood Investor Presentation Q1’22

But here’s an interesting point – what about the number of funded accounts on Robinhood?

Robinhood Net Cumulative Funded Accounts

Robinhood Investor Presentation Q1’22

So monthly active users are plummeting, revenue is plummeting, but has the number of funded accounts been pretty steady over the past year?

This is, again, down to the problems with Robinhood’s business model – it doesn’t make much money for investors who buy and hold, and these are the users who will happily leave their money in their Robinhood accounts for years to come. come.

Conclusion

I think that last graph shows that Robinhood brings some value to this world; it’s a great user-friendly platform that anyone can use to invest in the world’s greatest wealth-creating machine: the stock market.

But in my opinion, it’s a broken business right now. The company highlights its expansion into crypto in the Investor presentation Q1’22and that’s not what the company should focus on – leave that to a specialist like Coinbase (COIN), which is also struggling.

I believe Robinhood fails to solve its main problem; the business model he is currently using is unsustainable and relies far too much on the hype surrounding both stocks and crypto. Since Robinhood makes a significant amount of income based on options trading, they would clearly benefit from more people using them. As a result, Robinhood has been accused of not having rigorous enough controls and potentially giving access to these complex financial products to people who are not appropriately qualified.

I’ve never written an article with a “sell” recommendation before, but I’ve never seen such a bad company; Unless Robinhood quickly changes its business model, this business is doomed.

Comments are closed.