A week after going public, the online trading company is off to a volatile start.
Robinhood shares fell 28% to $50.97 on Aug. 5 after a brief rally earlier in the week. Originally priced at $38 on its first day of trading, shares of HOOD rose to $70 on Wednesday. But the surge was short-lived after the company revealed on Thursday that early stakeholders will sell up to 97.9 million shares over time. Among the sellers are venture capital firms that rescued Robinhood during the "meme stock" scandal in January, including New Enterprise Associates, which owns more than a 10% stake in the company.
Before its initial public offering, Robinhood said it netted roughly $1.89 billion from the sale of 55 million shares, giving it an approximate valuation of $29 billion.
Robinhood 101: Growth amid controversy
Though it was founded in 2013, the financial services company has grown rapidly. It now boasts the third-largest number of funded accounts in the US -- 22.2 million -- trailing only Fidelity and Charles Schwab, two institutional behemoths that have been around for decades. Robinhood's main product is an app designed to allow individual investors to buy and sell stocks without commissions or a financial broker. Robinhood also offers cryptocurrency trading and cash management accounts.
The company's stated mission is to "democratize finance for all." So far, it has successfully created an approachable, low-cost platform that has attracted a critical mass of new and young investors. The company's revenue grew to $959 million in 2020, a 245% increase year-over-year. Its first-quarter earnings were $522 million, a 309% increase year-over-year.
Amid its growth, Robinhood has been swept into controversy. On Jan. 28, Robinhood issued a statement saying it would not allow customers to buy stock in companies including GameStop, AMC Entertainment Holdings and Nokia. This decision was made in response to heavy trading volume stemming from coordination by members of a Reddit community, WallStreetBets, which drove up the share price of these so-called "meme stocks." The fallout, which was dramatic, severe and multifaceted, included an emergency injection of capital into Robinhood, an arousal of interest from elected officials and federal agencies, and the fury of its customer base.
The backlash also included nearly 50 lawsuits against the company -- a significant risk that investors will continue to monitor. In June, the Financial Industry Regulatory Authority fined Robinhood $57 million and ordered nearly $13 million in restitution to customers -- the largest fine ever imposed by the regulatory organization.
"In determining the appropriate sanctions, FINRA considered the widespread and significant harm suffered by customers, including millions of customers who received false or misleading information from the firm, millions of customers affected by the firm's systems outages in March 2020, and thousands of customers the firm approved to trade options even when it was not appropriate for the customers to do so," the organization said in a press release.
But controversy has swirled since Robinhood's founding. Critics have suggested that the platform's "gamification" represents a particular danger to the inexperienced traders that make up a significant share of its user base. In 2020, a 20-year-old college student killed himself after he mistakenly believed he had lost more than $700,000 in trading losses on the app. Robinhood was specifically named in the suicide note.
How investors should think about Robinhood
There's no denying that Robinhood is popular, but it's important to look beyond the headlines and hype when deciding whether to invest in the company's stock. Serious investors inspect a company's financial statements to understand its business model, opportunities and vulnerabilities. Before going public, every company needs to file a registration statement -- also known as an S-1 -- with the Securities and Exchange Commission. (You can find any company's S-1 by entering its name on the SEC's EDGAR filings website.)
At the beginning of an S-1 statement, you'll find a prospectus and summary that provide information. The key items are:
- A detailed company description
- Financial and operating history
- Products and services
- Primary markets
- Competitor information
Reading a company's S-1 statement is a good way to learn about a company before investing. Here are a few things to scrutinize as you consider any investment.
How long has the company been in business?
In 2019, Goldman Sachs analyzed 4,481 IPOs over 25 years to determine the critical factors to a successful IPO. They found that although age wasn't a "significant indicator" of outperformance, firms founded five years or less before IPO yielded 50% sales growth after five quarters, compared to 30% for firms aged 5 to 15 years and 19% for firms 15 years and older.
Who runs the show?
Company management plays a crucial role in overall operation and strategy. When deciding whether to invest in a new IPO, do some digging into the professional backgrounds of the founders and executive staff running day-to-day operations. Have they ever managed a publicly traded company? What's their track record of success, and how does it compare with the company's stated values? Robinhood's executive team is profiled here.
What's the market landscape?
A company's potential for long-term success goes beyond its profitability: Looking at the overall industry can be a good indicator. In their S-1 filings, companies are eager to recruit new investors and provide a list of studies and research supporting industry growth. You can also do your own research by reading the latest info collected by trade magazines, FINRA, the Pew Research Center, Morningstar, the SEC and others.
What's the plan for growth and profitability?
Understanding how a company plans to invest its capital and expand the business is an effective way to gauge its financial strength. In addition to the S-1 statement, a company's latest income statements, cash flow statements and balance sheets are a good place to start.
- Income statements detail how much a company has earned over a set period. The statement includes company expenses like goods sold, general and administrative fees, interest and taxes. You can subtract these expenses from the listed gross revenue to learn the company's net income.
- Cash flow statements show how money flows in and out of a company within three categories: operating, investing and financing. Together, these categories provide a snapshot of the core business, payments to suppliers and third parties, property and security costs and gains, shareholder dividend payments, cash received through issuing stocks and the owners' equity.
- Balance sheets detail a company's assets, liabilities and shareholder equity. A balance sheet can provide a snapshot of company health by weighing how much a company owns against its debts and how much equity is held by shareholders.
In addition to getting a clearer financial picture, you can also compare a company's financials with its stated growth initiatives. For example, Robinhood said that it plans to market to and grow its customer base through the Robinhood Referral Program, which rewards customers up to $500 in reward stock when friends sign up for Robinhood through their referral link. After linking their bank account, new customers also receive a $500 stock credit. Robinhood also shared plans to expand to international markets in Europe and Asia while also improving its platform through "product innovation, educational content, technology and infrastructure improvements and customer support." Whether the company plans align with practice depends on the numbers.
Who are the competitors?
Every stock comes with risks, and a company's IPO success depends largely on how investors measure its ability to compete with the competition. Learning more about each company's operating practices and market share is the best way to determine a newcomer's chances of disrupting and establishing itself in the industry. Robinhood listed E**Trade, Fidelity Investments, IBKR, M1 Finance, Schwab, TD Ameritrade, Thinkorswim, Vanguard and Webull as its main competitors.
Minimize your risk
If you're sold on buying into the latest IPO but still concerned about risk, there are a couple of ways to limit your exposure. You don't have to buy as soon as an IPO hits the market. In fact, nearly 50% of IPO shares decrease in the first 48 hours, according to Nasdaq, essentially narrowing the chances of early profitability down to a coin toss. Consider a wait-and-watch strategy and buy when the stock dips to maximize your initial earnings.
Rather than buying individual company shares, you can also hedge your investment by buying shares of an exchange traded fund that includes the stock you're eyeing. ETFs are a collection of investments that can include stocks, bonds and commodities. Their diversification comes with less risk than playing the odds with a single stock. Stock ETFs that target a single industry can provide investors with exposure to a combination of established companies and newcomer stock offerings.