It’s all come full circle. The brokerage app popular with “meme stock” traders is now a “meme stock” itself. But does that mean you should dive into Robinhood Markets (NASDAQ:HOOD) stock right after its recent IPO? Not so fast.
Yes, despite its first day hiccup, it’s performed well since its debut on the NASDAQ exchange earlier this month. Priced at $38 per share, as of this writing it trades for around $57 per share. Yet this may not last for long.
Conversation about it on Reddit’s r/WallStreetBets subreddit has been trending lower. At some point its rich valuation is going to catch up with it. Even if, for now, bears are too scared to short the stock directly.
In addition, the stock’s continued move higher hinges entirely on retail trading, and the market overall, remaining in its current state. If markets correct in the months ahead? Say goodbye to the retail trader renaissance that kicked off at the start of the Covid-19 pandemic. Say goodbye as well to this stock remaining at its currently inflated prices.
The verdict? Don’t buy what MarketWatch has called “the first meta-meme stock.” Too dependent on current trends, and so far unable to break away from its “fun” reputation, there are many ways it could disappoint going forward.
HOOD Stock, its Valuation, and a Long-Term Risk to its Growth
The popularity of its platform and its stock with retail traders may signal to you that shares have more room to run after their first IPO pop. Yet take a look under its “hood” (pun intended), and it’s clear there’s not much to be excited about buying in at today’s prices.
Why? With HOOD stock, the phrase “priced for perfection” may be an understatement. Right now, it trades at a forward price-to-earnings (P/E) ratio of 172.2x, based on analyst consensus for 2022 (analysts project negative earnings for 2021). As long as the stock market remains more concerned with revenue and earnings growth, rather than with valuation, this could hold.
Yet even if markets do not correct soon down the road (more below), who’s to say Robinhood Markets will continue to grow in line with investor expectations? The brokerage’s platform past success may not mean it’s on its way to supplant traditional brokerage houses like Fidelity and Charles Schwab (NYSE:SCHW), in terms of assets under administration.
Between customers using it for speculative trading, but keeping their nest eggs elsewhere, and once-newbie investors “moving on” to more serious platforms after they’ve gained experience, what’s worked for Robinhood in the short-term (make investing more “fun” for those in the Millennial and Gen-Z generational cohorts) may backfire in the long-term.
Very Vulnerable if Markets Correct
Thanks to the retail trading boom that kicked off last year, Robinhood saw its revenue more than triple, from $277.5 million in 2019, to $958.8 million in 2020. Much of this came from its customer growth. Yet the unique way this platform generates the bulk of its revenue played a role in this as well.
This commission-free platform generates revenue via payment for order flow, or PFOF. In a nutshell, Robinhood routes trades on its platform to market makers, who make money from executing the trade from the bid/ask spread. Market makers rebate a portion of this back to Robinhood, as compensation for sending them trades from their platform. As InvestorPlace’s Mark Hake recently discussed, there’s a lot of controversy with this revenue model.
But there’s a larger issue that stems from its dependence on PFOF. That would be whether its revenues stay strong, if a market correction happens? An across-the-board decline in stock prices could also mean lower amounts of trading by retail investors. Less orders mean less payment for order flow.
In turn, that’s bad news for its shares. Investors are willing to pay up for it as long as revenues continue to grow at an above-average clip. If growth takes a hit? Expect HOOD stock to see an outsized decline, if markets overall correct.
Too Pricey and Too Trendy, Hold off Buying
Thanks to the sharp increase in retail trading, things have been booming for the brokerage platform. But that won’t be the case if markets correct sometime in the months ahead. A return to a bear market could mean lower amounts of stock trading. In turn, lower revenues, and more likely than not, a lower price for Robinhood shares.
Even if a hard landing isn’t in store for the markets? The fact it’s still viewed as a place to make “fun” trade, rather than a serious place to invest is a risk as well. It could mean its growth runway is much more limited than what’s implied today with its rich valuation.
Bottom line: too pricey, and too trendy, the best move with HOOD stock is to hold off buying.
On the date of publication, Thomas Niel did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Thomas Niel, contributor for InvestorPlace.com, has been writing single-stock analysis for web-based publications since 2016.