Investing in Robinhood Markets(NASDAQ: HOOD) has been a rollercoaster. The new-age stock brokerage and financial services company began trading at $38 per share in the summer of 2021 but has bounced around, peaking at $70 before falling below $7 just a year later.
The company is growing thanks to innovative products and a well-designed trading platform. The stock has responded, surging 240% over the past year, which is impressive, even if it has barely reclaimed its IPO price.
Now the question is, what comes next? In other words, should investors buy, sell, or hold the stock?
Robinhood's recent business momentum is exciting, but the roller-coaster-like volatility may not be over. Here is what you need to know.
An innovative but fragile business
Regardless of what you think of Robinhood, the company deserves credit for disrupting the brokerage industry. It got its foot in the door by offering commission-free trades, and today, most brokerages have followed suit. Robinhood isn't perfect. Over the years, it has received its share of backlash, receiving scrutiny for the payments it receives for its order flow and how it handled the infamous GameStop short squeeze in early 2021.
But Robinhood has strived to evolve into a platform where people can take their finances seriously. That has included launching individual retirement accounts (IRAs), a credit card, and a subscription service with numerous perks. It seems to be working. In Q3, the company's customer base grew by 1 million year over year, including a 76% jump in assets under custody (AUC) as people funded their retirement accounts there.
The momentum has helped turn the company generally accepted accounting principles (GAAP) profitable, with $525 million in net income over the past four quarters on $2.4 billion in revenue.
Unfortunately, the underlying financials may not be as impressive. Retirement accounts are necessary to grow the platform, but they aren't nearly as lucrative as margin loans and options contracts. Margin loan interest and options fees account for 39.5% of Robinhood's total revenue through nine months of 2024.
These types of speculative activities dry up during market downturns. After the market's two-year rally, which seems like forever ago, Robinhood's monthly active user count plummeted from 21.3 million in Q2 2021 to 10.8 million in Q2 2023, when the market declined amid rising interest rates. Speculation-driven revenue could fall again if investors step away from their portfolios during the next (inevitable) market decline.
The uncertainty could weigh on the stock
Investors could (rightfully) be more cautious about the valuation they pay for a stock if the earnings supporting that valuation aren't entirely dependable. That has nothing to do with Robinhood's business or integrity; instead, it's a cyclical business that will fluctuate with the broader market until it grows big enough in other areas that it doesn't depend so much on trading activity.
That's why the company is trying to generate new, more stable revenue from its credit card and subscription service.
Investors should weigh this when looking at the stock. Robinhood currently trades at a forward P/E ratio of 29. Meanwhile, analysts expect the company to grow earnings by an average of 7% annually over the next three to five years:
Nearly 30 times earnings is a steep price tag for just single-digit growth. Investors buying here are probably looking for Robinhood to outperform current expectations. That's certainly possible, but again, you shouldn't dismiss the risk a market downturn poses to the business.
Is the stock a buy, sell, or hold?
If the past few years are any indication, the stock will have more ups and downs. Given the stock's epic rally and hefty valuation, investors should consider it a hold and wait for a pullback.
If you're investing for years into the future, consider a dollar-cost averaging strategy. Admittedly, deciding when to buy volatile stocks is extremely difficult because nobody can predict what will happen (or when). You can add shares slowly, averaging your cost out over time.
Eventually, as Robinhood grows its newer revenue streams, the business (and the stock's price action) may smooth out.
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Justin Pope has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
