Earlier this month, I warned investors to stay away from Robinhood (NASDAQ:HOOD) stock, at least for now.
Since that story was published, Robinhood released its first quarterly earnings report since its initial public offering. Now, there are three brand new reasons to stay away from HOOD stock.
1. HOOD Stock Is Not Profitable
There are plenty of growth stocks out there that aren’t profitable. Robinhood reported a net loss of $502 million in the second quarter. Somehow, in the middle of the biggest retail trading boom of all time, the most popular retail trading app is losing half a billion dollars per quarter.
I know Robinhood is investing in growth initiatives. But it’s hard to imagine market conditions will ever get better for Robinhood than they are today.
David Trainer, CEO of New Constructs, says Robinhood has a lot to prove when it comes to profitability.
“Robinhood’s net operating profit after-tax (NOPAT) margin, and [return on invested capital] rank below brokerage peers. While the company’s balance sheet efficiency (invested capital turns) ranks second highest of the group, it has not translated into meaningful profit generation,” Trainer says.
In fact, while Robinhood reported a $500 million loss, Charles Schwab (NYSE:SCHW) generated a $1.2 billion profit in the second quarter.
If Robinhood is struggling to generate profits now, I can’t imagine things will get any easier in the near future. Stock trading won’t always be the trendy thing to do on TikTok. People won’t continue to be stuck at home with few travel or entertainment options. And young traders presumably won’t continue to get periodic government stimulus checks.
2. Terrible Guidance
The biggest driver of the post-earnings sell-off in HOOD stock was the company’s guidance. In the third quarter, management said it is anticipating “seasonal headwinds” and “lower trading activity.” That prediction comes as no surprise to me. Why do investors think Robinhood chose July 2021 for its IPO? It’s reporting staggering growth numbers that the company knows it won’t be able to continue in the future. Now is the perfect time for company insiders to dump their shares and get out on a high note.
Robinhood has huge lockup expiration dates coming on Oct. 27 and Dec. 1. I’m guessing based on management’s commentary Robinhood will report some abysmal growth numbers in the third quarter. That report will be coming in November. So what are company insiders likely to do when the first lockup period expires on Oct. 27?
3. Super-Sketchy Business Model
What stood out to me the most about Robinhood’s earnings report was its revenue mix. Cryptocurrency accounted for 52% of Robinhood’s transaction-based revenue in the second quarter. Of that $233 million in crypto revenue, a mind-blowing 62% came from Dogecoin (CCC:DOGE-USD). Yes, that’s right. More than 60% of Robinhood’s largest source of revenue comes from the joke dog cryptocurrency. Robinhood even specifically mentioned a decline in Dogecoin transactions as a potential risk to its business moving forward.
Robinhood did not provide a breakdown of how much of its trading revenue came from meme stocks like AMC Entertainment (NYSE:AMC) and GameStop (NYSE:GME). But it did say that options accounted for $165 million in transaction revenue and stocks accounted for just $52 million. Option trading is far more speculative and high-risk than stock trading or long-term investing. Berkshire Hathaway (NYSE:BRK.B) vice chairman Charlie Munger has publicly ripped Robinhood for making money in a “dirty way.”
“Robinhood belongs in the Hall of Shame alongside e-cigarette company Juul and Oxycontin maker Purdue Pharma for pushing products that hurt people,” former hedge fund manager Whitney Tilson said back in July. “Robinhood’s entire business model depends on further turning our markets into, as Munger put it, ‘gambling parlors’ – encouraging people to speculate madly by day-trading options and worthless garbage that I’ve nicknamed Doggycoin (DOGE-USD) and GameStink (GME).”
Second-quarter numbers suggest gambling, not investing, is a far bigger part of Robinhood’s business than Munger or Tilson likely realized.
How To Play It
I really struggle to find a reasonable bull case for HOOD stock at its current $42 billion valuation.
Robinhood is an extremely high-risk speculation. If you’re looking to make a long-term investment in HOOD stock, I recommend waiting at least another six months. That way, you can avoid at least some of the near-term risks the company is facing.
On the date of publication, Wayne Duggan held a long position in BRK.B. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Wayne Duggan has been a U.S. News & World Report Investing contributor since 2016 and is a staff writer at Benzinga, where he has written more than 7,000 articles. Mr. Duggan is the author of the book “Beating Wall Street With Common Sense,” which focuses on investing psychology and practical strategies to outperform the stock market.