Editor’s Note: This article was updated on Aug. 5. 2021, to correct the name of one of the companies included.
Shares of the $0 commission investing platform Robinhood Markets Inc. (NASDAQ:HOOD) made their debut on the public markets yesterday in one of the most widely discussed IPOs of 2021.
The stock initially sold for $38 per share, giving it a value of about $32 billion, well above the company’s estimated value of $11.7 billion at a funding round in September. The company said it raised nearly $2 billion through the IPO, while shares fell over 8% on its opening day.
Robinhood grabbed headlines early in the year amidst the meme-stock frenzy that led to highly volatile trading in stocks like GameStop Corp. (NYSE:GME) and AMC Entertainment Holdings, Inc. (NYSE:AMC).
CEO Vladimir Tenev withstood pointed questioning by Congress about the company’s business practices, particularly its reliance on earning most of its revenue through payment for order flow (PFOF). That’s basically when market makers like Citadel Securities pay fees to brokerage firms to fulfill the orders of the stockbrokers’ clients.
More recently, the company has faced criticism for raking in about a third of its crypto-based transaction revenue — roughly $30 million — during the first quarter related to trading Dogecoin, a cryptocurrency that skyrocketed during the meme trading frenzy and has since fallen 63% from its high on May 14.
In the case of Robinhood, 81% of its first-quarter revenue was derived from PFOF, especially from options and theme exchange-traded funds (ETFs), which have much wider spreads than stocks.
The new Securities and Exchange Commission (SEC) Chairman Gary Gensler is reported to be wary of PFOF and the SEC is in the process of reviewing PFOF and may propose some changes that will likely be subject to public comments before any new rules go into effect.
Interestingly, PFOF has existed for decades, but with the Citadel Securities algorithms taking over Wall Street trading, plus the boom in ETFs, which put another bid/ask spread onto securities with existing bid/ask spreads, Wall Street firms have effectively figured out how to “double dip” via the ETF industry.
The analysts at Bespoke have documented how some of the most popular ETFs, like the SPDR S&P 500 ETF (NYSEARCA:SPY) and the Invesco QQQ (NASDAQ:QQQ), actually lost money if you bought them at the opening and sold them at the close every day since their inception. This important Bespoke research proves that ETFs are not designed to be activity traded, since the bid/ask spreads can be cost prohibitive, especially during fast market conditions.
Typically, ETF spreads are “tight” at the market opening and close but can widen dramatically during the middle of the trading day. I know all this because I had my own ETF a while ago and was shocked that, according to Morningstar, the average spread to buy and sell my now defunct ETF was 3.54%.
I should add that I was never compensated in any way from my ETF, which was sold to Oppenheimer. However, had I been a broker dealer, I could have received a PFOF from the bid/ask spread.
Most investors have no idea that ETFs have a bid/ask spread on top of the underlying security spread.
The theme ETFs — for example, those that specialize in Environmental, Social and Corporate Governance (ESG), cannabis, robotics, etc. — are notorious for super wide ETF spreads that can be incredibly lucrative for some broker dealers.
The bottom line is that I applaud the SEC for investigating PFOF but expect they may not be able to stop a practice that has existed for decades. However, perhaps the SEC can mandate a big warning label, like the one for cigarettes, to alert investors that they could get “fleeced” on ETF spreads, especially the theme ETFs that are notorious for wide bid/ask spreads.
Choosing the Best Stocks
Either way, I’m not a fan of IPOs like Robinhood that haven’t had the track record to prove their superior fundamentals.
So while I can’t recommend Robinhood at this time, there are plenty of other fundamentally superior stocks that are worth your time. But if you’re having trouble finding them, then you need look no further than my Platinum Growth Club.
Earnings reports for my Model Portfolio stocks will be coming in fast and furious over the next few weeks. And I expect their solid results to dropkick the companies’ stocks and drive them higher. If you want to get in before the stocks take off and get the most bang for your buck, now is the time to join.
My Platinum Growth Club service comes with my exclusive Model Portfolio. I handpick all of my Model Portfolio recommendations from my different stock services — Growth Investor, Breakthrough Stocks and Accelerated Profits — so you can rest assured that you’re always invested in the crème de la crème.
Speaking of Growth Investor, I am releasing my Growth Investor Monthly Issue for August today. I’ll reveal three brand-new buys, all of which are defensive, high-dividend growth stocks that I anticipate will be incredibly resilient in the upcoming weeks. I’ll also release my latest list of Top 5 stocks. As a Platinum Growth Club subscriber, you’ll have full-access to it (as well as my other services).
So, if you want to make sure your portfolio is “locked and loaded” with fundamentally superior stocks for the long term, I encourage you to sign up for Platinum Growth Club today.
Note: The Editor hereby discloses that as of the date of this email, the Editor, directly or indirectly, owned the following securities that are the subject of the commentary, analysis, opinions, advice, or recommendations in, or which are otherwise mentioned in, the essay set forth below:
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