Robinhood (HOOD) – Get Robinhood Markets Inc. Report stock has been in freefall since August of last year. The commission-free broker suffered greatly after seeing a slowdown in the substantial growth it experienced during the meme and crypto frenzy of Q1 2021.
Along with several macro-related headwinds – a bear market and a crypto winter chief among them – now, payment per order flow is under SEC scrutiny. Thanks to this litany of adverse conditions, many experts have recently reinforced their “sell” recommendations on Robinhood stock.
Figure 1: Is Shorting Robinhood Stock a Good Idea?
Robinhood
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Robinhood’s Business Risks
There are considerable risks facing Robinhood’s current business model. According to the HOOD’s Form 10-K, the company’s short operating history, its difficulties managing its fast-growing business, and fluctuations in the company’s quarterly financial results are significant risks to consider when investing in Robinhood stock.
Apart from these risks, there is another considerable one to watch out for: the dependence of Robinhood’s revenues on payment per order flow (PFOF).
Payment per order flow is compensation received by a broker (e.g., Robinhood) from buyers, such as wholesalers, who have an interest in directing order flow (i.e., retail buy and sell orders of stocks, options, etc.). Generally, buyers pay brokers a few cents per transaction for the right to route orders to a specific market maker. Other big brokerages besides Robinhood, including TD Ameritrade, Charles Schwab, and E-Trade, use PFOF.
The practice of payment for order flow is controversial and has been heavily criticized by retail investors. They believe PFOF involves inherent conflicts of interest for the parties involved. PFOF is illegal in several other western nations, including Canada and the UK, among others.
And the practice doesn’t have a phenomenal pedigree. One of PFOF’s biggest original advocates was maker Bernie Madoff, now famous for his fraud and financial crimes.
There are also theories that the practice of PFOF can turn executable orders into non-executable ones. This is thought to occur when trades are rerouted to market makers who are willing to pay a higher fee to brokers. Non-executable orders can, in turn, damage asset prices, especially during periods of high trading volume. I.e., PFOF may adversely affect the share price of stocks that retailers are trying to buy or sell.
PFOF Under SEC Scrutiny
As a commission-free broker, Robinhood derives nearly 80% of its revenues from PFOF. An eventual ban of this practice would spell major trouble for the company. And though we don’t yet know if such drastic action will be taken, we do know the SEC has plans to scrutinize the practice.
Recent revelations from SEC Chair Gary Gensler indicate that the SEC is putting in place a plan that will require trading firms to compete with each other to execute retail investors’ trades.
Gensler notes that, currently, 90% of orders coming from retail investors are routed to a small subset of wholesaler market makers. He believes this trend warrants a closer inspection of PFOF and has indicated that an order-by-order competition model may lead to greater transparency for retail trades.
Robinhood’s Chief Legal Officer Dan Gallagher has come out against the SEC’s plans, saying the efforts regarding the stock market are “misguided.” Gallagher claims that the trading status quo works well for ordinary investors.
Wall Street Bearishness: Robinhood’s Decaying Metrics And Growth Skepticism
Robinhood’s monthly active users (MAU) metrics have been declining rapidly since last year. MAUs currently stand at 14.6 million, down 7% on the month and down nearly 40% YoY. That’s all during a time of nearly unprecedented market volatility, See below.
Figure 2: Robinhood’s monthly active users.
Robinhood’s IR
The average revenue per user (ARPU), meanwhile, has fallen 60% since its peak in Q1 of 2021. According to Atlantic Equities analyst John Heagerty, these two metrics alone justify bearishness on Robinhood. Heagerty recommends selling the stock and has assigned HOOD a target of $5 per share.
Figure 3: Robinhood’s average revenue per user.
Robinhood’s IR
Compounding these issues, Robinhood’s margins have fallen almost 20% month-on-month to $4.2 billion, according to the latest financial results reported in May. In a recent report, J.P. Morgan analyst Kenneth Worthington says that Robinhood’s growth is not sustainable. This is despite the company’s founders’ ability to leverage courage, innovation, and ideal market conditions to build a leading retail broker. Worthington recommends selling Robinhood shares and has a price target of $7 per share.
(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting Wall Street Memes)
