Robinhood (NASDAQ:HOOD) is a commission-free stock trading and investing app that has gathered a lot of attention. In particular, HOOD stock has generated quite a bit of controversial attention amid the recent meme stock frenzy and overall disruption of the stock market brokerage industry.
During the frenzy starting last March, shares of meme stocks like AMC (NYSE:AMC) and GameStop (NYSE:GME) traded heavily on Robinhood, creating a lot of volatility. This chaos in mind, there are several reasons I do not like HOOD stock.
Here’s what you should know about shares moving forward.
HOOD Stock: Another Unsuccessful IPO
Let’s first start with HOOD stock’s initial public offering (IPO).
Making its debut last summer, Robinhood priced its shares at $38. On Feb. 18, however, the stock closed at $11.81. That represents a loss of nearly 69% from the IPO price. So far in 2022, shares have fallen approximately 38% as well. If anything, HOOD stock is an example of why retail investors should approach all IPOs very cautiously. Often times, offering prices are just too rich.
There’s more to worry about than the share price here, however. In particular, I find it both interesting and alarming that Robinhood agreed to pay around $70 million to the Financial Industry Regulatory Authority (FINRA) before going public. The company did so in order to “settle allegations that the brokerage caused customers ‘widespread and significant’ harm on multiple different fronts over the past few years.”
While these were allegations, false and misleading information for a brokerage service is a huge red flag. At the least, that raises my eyebrow when it comes to HOOD stock.
The Battle Between Investing Generations
Charlie Munger and Warren Buffett are legends when it comes to investing. I have tons of respect for them myself.
When it comes to HOOD stock, though, Munger has made some intriguing comments about retail trading apps. Specifically, he has named them responsible for the recent “speculative mess.” Munger added:
“We now mix up a legitimate activity — capital raising for enterprises that need money to do their capitalistic function with a gambling casino, where people come in gamble […] It isn’t good to have a lot of people trying to get easy money for sure just from gambling.”
Charlie Munger has also stated that meme trading is like a “drunken brawl.” Back in 2021, however, Robinhood replied to both Buffet and Munger, saying that the oracles of investing had “insulted a new generation” of investors. The company added that it was making “investing simpler and more accessible to more people.”
What’s my take on this?
No doubt, Robinhood has made investing more accessible and become a been a pioneer with its mission to “democratize finance for all.” It has made fractional shares available, for instance. Fractional shares mean that investors can invest any amount and it will be converted to parts of a whole share, helping them build a balanced portfolio.
There is an important disclosure to read with fractional shares, however. Robinhood says that “fractional shares are illiquid outside of Robinhood and not transferable.” In other words, you can have a severe liquidity problem with them. That’s not such a great advantage when it comes to stock trading.
Investing is all about education and knowledge. First-time investors on Robinhood who rushed to buy meme stocks either made money or lost a lot of it. And if they won, these investors may consider themselves to be great stock pickers when they’ve actually just lucked out amid the chaos. That false confidence is also not good.
Will the SEC Ban Payment for Order Flow?
And there’s even more to be worried about with Robinhood. Have you ever heard the expression there is no such thing as a free lunch? In this company’s case, the free platform is actually supported by payment for order flow (PFOF). Brokers receive payments from dealers via routing trades to them.
What Robinhood did with zero-commission trades now has been copied by other investing apps and brokerage services. To the investors, the idea seems to be an ideal situation. After all, you can trade for free. But there is actually a very important ethical problem.
The issue? Robinhood has incentive to direct trades to market makers offering the highest bid-ask spread, as this will increase its profit. Market makers can make a higher profit and themselves pay a higher amount of money to Robinhood. So, in that sense, there is a strong conflict of interest between Robinhood and its users.
High bid-ask spreads increase the volatility of the stock market. The U.S. Securities and Exchange Commission (SEC) is already monitoring the situation and could ban PFOF. If this happens, it would be detrimental to Robinhood’s revenue and HOOD stock.
Robinhood Is a Trading Pioneer, But It Has Risks
Currently, the SEC is also considering changing its trade settlement times. Robinhood could be one of the reasons for this shift. That potential change in settlement times could both lower risk and improve efficiency in capital markets.
Looking at its fourth-quarter and full-year 2021 financial results, however, Robinhood reported a net loss of $423 million for the quarter, or 49 cents per diluted share. For 2021, the net loss was $3.69 billion, or $7.49 per diluted share. Year-over-year (YOY), the company’s profitability has deteriorated significantly. For full-year 2020, Robinhood had net income of $7 million.
All told, I see a lot of problems here and a business model that’s not really working. There are some interesting aspects to the company. Still, altogether avoiding HOOD stock makes perfect sense.
On the date of publication, Stavros Georgiadis, CFA did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Stavros Georgiadis is a CFA charter holder, an Equity Research Analyst, and an Economist. He focuses on U.S. stocks and has his own stock market blog at thestockmarketontheinternet.com. He has written in the past various articles for other publications and can be reached on Twitter and on LinkedIn.