The firm filed its S-1 with the Securities and Exchange Commission on July 1 and is seeking to raise about $2 billion from the sale of 54.6 million shares at a price of about $38 to $42 each. The IPO would give Robinhood a market valuation of about $35 billion, which is about $100 billion less than the market cap of Charles Schwab, the discount brokerage pioneer. Unlike most IPOS, where the vast majority of shares go to big institutional investors, up to 35% of Robinhood’s shares are reserved for retail investors, which the company says is aligned with its mission statement to democratize finance.
The company, which became a household name for novice investors in recent years, offers customer users commission-free trading as part of its effort to “democratize trading for all.” But in its short history, the company has generated more than its share of proponents and detractors. Some see its trading app as providing access to a new generation of investors while others are more wary and cite the custodian’s rocky past.
Should You Invest in Robinhood?
Whether you should invest in Robinhood depends on many factors. As you would when investing in any stock, your knowledge of the company is vital: its business model and future prospects, its risk factors, its competition, its legal woes, and so on.
Steal From the Rich, Give to the Poor
You can learn plenty about Robinhood by reading the company’s S-1 filing. You don’t have to memorize the entire lengthy document but it’s a good idea to review the company’s financial and operating data, its balance sheet, and the like.
Here’s the short version if you don’t have time to read the S-1.
Founded in 2013, Robinhood was conceived as a response to the Occupy Wall Street movement. In an effort to involve more of the general public with investing in the stock market, the app offered commission-free trading for retail investors. While other brokers have followed suit, such as Charles Schwab and Fidelity, Robinhood’s game-like interface appeals to adults new to investing.
In fact, more than 50% of users are first-time investors. The app has many features that appeal to young investors including a gamified design, the option to buy shares of cryptocurrency, and the ability to buy fractional shares.
What’s more, Robinhood’s revenues, profits, and assets under custody have skyrocketed thanks in large part to the trade of “meme stocks” such as Gamestop and AMC. Total revenue grew 245% to $959 million in 2020, up from $278 million in 2019 and net income rose to $7 million in 2020, compared to a net loss of $107 million in 2019, according to the company’s S-1. Customer assets under custody rose to $81 billion in March 2021 from $19 billion in 2020.
Despite its young age, Robinhood has found itself in a fair amount of legal trouble. The company was fined $70 million by the Financial Industry Regulatory Authority (FINRA), the largest penalty ever ordered by the agency.
FINRA states that the company’s “systemic supervisory failures and significant harm suffered by millions of customers” warranted the penalty. Robinhood was accused of providing misleading information to new investors, such as what “trading on margin” meant.
Additionally, the platform experienced outages during the highest-volume trading days of March 2020. As a result, users were unable to sell their assets.
FINRA also mentioned in the release the details regarding the suicide of a 20-year-old trader who believed he had racked up over $700 thousand in losses. Before his death, he tried to contact Robinhood’s customer service multiple times, only to be met with automated replies. This figure was inaccurate, and an email was sent absolving him of his financial losses the day after his death.
FINRA hasn’t been the only firm to call out Robinhood on negligent practices. In March, Robinhood had to decrease the amount of game-like features on the app, including celebratory confetti after making a trade. Regulators including the Massachusetts Securities Division have accused the platform of preying on inexperienced investors by employing game-like tactics and are seeking to have Robinhood’s broker-dealer license revoked in the state. William Galvin, the head of the Securities Division, claimed that the resulting lawsuit is “another example of Robinhood’s complete rejection of responsibility to their customers” in a recent statement.
Financial Food for Thought
Despite some of its shortcomings, there are a few valid reasons to invest in the app. One can’t overlook the substantial growth in users within the past few quarters. The company has grown its funded accounts to 18 million in March of this year from 7.2 million in 2020, an increase of 151%. Monthly active users total about 17.7 million. Assets under custody have grown from $80 billion to $19.2 billion last March.
Brand recognition is also key. The platform is the main custodian of choice within the large stock-trading community on Reddit. This is no small following; over 10 million follow the subreddit, “r/wallstreetbets”. The page acts as a forum for investors to discuss the hottest stock trends, and users participate in the Reddit discourse by making the bulk of their trades on Robinhood.
Reasons Not to Invest
You don’t have to look far and wide to find reasons not to invest in Robinhood. As stated in its S-1, there’s an extensive list of risks: The company has a limited operating history, which makes it difficult to evaluate its business and prospects and increases the risks associated with an investment in its stock; the company has grown rapidly in recent years and it has have limited operating experience at its current scale of operations; the results of the company’s operations and other operating metrics may fluctuate from quarter to quarter, which makes these metrics difficult to predict; and the company has incurred operating losses in the past and may not maintain profitability in the future.
Another reason not to invest or at least wait to invest is this: You might have a fear of missing out on big gains, but that’s unlikely to happen given recent history. Six of the companies that have raised at least $2 billion in IPOs this year are trading 1.4% below their offering prices on average, according to data compiled by Bloomberg. In other words, it’s likely you won’t be missing out on anything if you don’t get IPO shares of Robinhood.
The biggest IPOs are lagging despite outperformance by large-cap stocks over the same period, according to a Bloomberg report. The Russell 2000 index has gained 7% this year, nearly half of the 13% climb by the S&P 500.
The takeaway? Don’t put all your eggs in one basket. If you do decide to invest in Robinhood, consider what Anthony Guzman, an associate wealth advisor at Pioneer Wealth Management Group, had to say: Make sure there’s no single holding that represents more than 5% of your overall portfolio.
Advice for Customers
Whether you invest in Robinhood’s stock or not, experts have advice for those who might want to use Robinhood’s app to buy and sell investments.
Haley Tolitsky, a CFP practitioner at Cooke Captial, advises that instead of jumping to make trades on Robinhood, research other custodians first. Many sources offer commission-free trading with better customer service and better stability, she said. Most even have a roboadvisor option, which creates catered financial services based on individual goals. She also warns against opening a taxable brokerage account on the site to save for retirement.
“That’s not the most tax-efficient way to do so,” she says. “You should rather open an IRA or Roth IRA. I don’t think people typically know the amount of accounts available to them.”
Tolitsky is quick to note the difference between investing and trading as well. For the younger crowd, the idea of waiting years for a significant return on investments may seem frustrating. Who wouldn't want to get rich quick?
“I think a lot of people are trying to become rich very quickly and just try to pick the best stock to make a huge profit. You want to make sure that you understand the tax ramifications from day trading,” she says. “There's a huge difference between day trading and building wealth for the long term by investing in the market.”
If you’re looking to achieve mid-to-long-term financial goals, consider less risky investments, such as mutual funds or ETFs that may provide steadier returns.
Critics of Robinhood also noted that users are able to trade on margin (with a Gold account, which costs $5 a month), which can be incredibly risky for novice and even experienced investors. While margin limits can be set, it is still easy to rack up losses.
Guzman found that buying and selling investments on Robinhood led to what could only be described as excessive. At one point, he had more than 75 holdings within his Robinhood account, but in 2020, he transferred all of his shares. For him, he was more comfortable investing in less volatile index funds as his financial goals evolved to support a new family.
“It became too much,” he says. “Managing multiple ticker symbols became too time-consuming.” As other brokers began to offer commission-free trades and fractional shares, he closed his Robinhood account for good.