Robinhood Markets (HOOD) went public at $38 a share last July, and the online broker’s stock closed less than a week later at an all-time high of $70.39. But it slipped below $10 last year as investors fretted over the company’s slowing growth, hefty losses and regulatory challenges.
However, one of the key regulatory headwinds for Robinhood — a potential ban on payment-for-order-flow (PFOF) trades by the Securities and Exchange Commission (SEC) — may finally be dissipating. According to multiple recent media reports, the SEC is on the verge of banning all PFOF trades, but it may still take unspecified steps to limit its profitability.
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Does this upside mean it’s finally safe to buy Robinhood stock? Let’s look at Robinhood’s growth rates, its reliance on PFOF trades, and some longer-term challenges and catalysts.
Why did Robinhood’s stock plummet?
Robinhood initially seemed poised to disrupt traditional brokerage deals by offering commission-free deals to smaller retail investors. It also won over first-time investors with its streamlined (and arguably “gamified”) app.
However, Robinhood’s pursuit of smaller and less experienced retail investors became a double-edged sword. Last year, Reddit-driven trading and stimulus checks propelled these investors into speculative meme stocks, risky options trades, and smaller cryptocurrencies in hopes of quick profits. As a result, its 2021 sales soared 89% to $1.82 billion.
But as interest rates rose, the market pivoted away from these riskier assets and into more conservative assets. That downturn, which led to a full-blown bear market this year, caused Robinhood’s growth in monthly active users (MAUs) and average revenue per user (ARPU) to falter.
As a result, the company ended the second quarter of 2022 with just 14.0 million MAUs, compared to 21.3 million MAUs a year earlier. ARPU also collapsed by 50% to just $56. The average size of each Robinhood account (calculated by dividing assets under custody by accumulated net funded accounts) also fell 38% year over year to just over $2,800. Total revenue fell 43% year over year in the first half of 2022, and analysts expect the full-year to fall 25%.
Those terrible numbers, along with ongoing losses, drove the bulls away. But even after that sharp drop, Robinhood’s stock still doesn’t look like a bargain at 6 times this year’s sales.
Does the SEC’s stance on PFOF trades change anything?
Robinhood subsidizes its commission-free trades through a PFOF system that routes its orders through High Frequency Trading Firms (HFT). HFT firms process so many trades that they are essentially the “market makers,” setting the bid-ask spread of many stocks. Therefore, an HFT firm can execute a “commission-free” order – executing the trade at the desired price for the individual investor – and still post a small profit on each trade.
Overall, these trades are so profitable for HFT firms that they are willing to pay brokers “rebates” to funnel millions of orders through their machines. Proponents of this PFOF practice claim it’s a win-win-win: Investors get commission-free trades, brokers get more clients, and HFT firms get more orders and book more profits. Meanwhile, critics claim that this practice prevents individual investors from ever getting the best price for a security, masks “real” prices, and makes markets more volatile with their rapid-fire algorithmic trades.
If the SEC bans all PFOF trades, Robinhood would likely have to start charging commissions. Many of its investors would likely balk at the idea, and its MAUs and ARPU would continue to atrophy.
However, an outright ban on PFOF trading never seemed a viable option to the SEC as many other major brokerage houses – including MorganStanley‘s E*Trade and Karl Schwab — also subsidize their commission-free deals with PFOF agreements. Even small investors have become accustomed to free stock trading.
A ban on PFOF trading would have posed major problems for Robinhood, but backing out of a ban won’t generate significant tailwind either, as it would merely be maintaining the status quo. Additionally, the SEC could still generate headwinds for Robinhood (including lower payments from HFT firms) if it finds other ways to limit the profitability of PFOF trades.
It’s still not the right time to buy Robinhood stock
Robinhood stock initially rallied on Sept. 22 in response to news about the SEC, but gave up those gains by the end of the day. The reason was simple: Robinhood still hasn’t solved any of its other pressing problems.
Instead, Robinhood recently announced that its MAUs fell to just 13.3 million at the end of August and that its assets under custody are still declining. Unless Robinhood stabilizes these ongoing losses, investors will continue to avoid its shares — regardless of what the SEC decides regarding PFOF trades.
Charles Schwab is an advertising partner with The Ascent, a Motley Fool company. Leo Sun has no position in any of the stocks mentioned. The Motley Fool recommends Charles Schwab. The Motley Fool has a disclosure policy.
