robin hood market (NASDAQ: Food) The stock has been on a tear lately, gaining a whopping 358% increase in the past 12 months alone. The company has benefited from increased activity in financial markets, with everything from stocks to cryptocurrencies reaching record highs in the past few months.
Robinhood is known for its ability to attract young first-time investors to its brokerage platform. This is something most of our competitors have struggled with. But the business faces structural challenges that will be very difficult to overcome in the long term, so investors should be very careful about the recent surge in the stock price.
In fact, I think Robinhood stock could plummet at least 50% from its current price of around $50 (as of this writing). Here’s why.
Robinhood has two main sources of revenue. Firstly, there is trading revenue that clients earn when they buy or sell stocks or cryptocurrencies. Second, there is net interest income. This is the interest you earn on the cash you hold in bank accounts on behalf of your clients (as well as your own cash).
Transaction revenue reflects the performance of Robinhood’s core business. In the third quarter of 2024 (ending September 30th), the company’s trading revenue was $319 million, the lowest level for the entire year (to be released on February 12th) .
The result was still below the quarterly peak of $451 million from 2021. For all the enthusiasm in the inventory, crypto and options markets over the last year, Robinhood’s core business is still smaller than it was at the height of Covid-19. Pandemic.
The significant drop in user base is why it’s important. In Q3 2024, Robinhood had 11 million active users, down nearly half from its peak of 21.3 million in mid-2021.
Many of Robinhood’s younger clients tend to be less sticky, as they enjoy making speculative bets using risky financial instruments like options. In other words, when they inevitably lose money, they leave the platform – and many of them don’t seem to be coming back.
That brings me to a very important point. Recent Robinhood stock reports that upcoming fourth quarter results, and ongoing results in 2025, could show significant improvement due to surge in trading activity after the November 5 US presidential election. This seems to be driven by speculation.
Early signs are promising. Robinhood’s monthly metrics report for November showed a 780% year-over-year increase in crypto trading volume and a 178% increase in stock trading volume. However, Robinhood’s track record suggests this is more likely to be a temporary blip than sustainable growth.
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Robinhood’s trading revenue from cryptocurrencies plummeted by 90% (from peak to trough), especially when brutal bear markets attacked the crypto industry in 2022 and 2023. They went from $233 million in Q2 2021 to just $23 million in Q3 2023. There’s nothing stopping it from happening again in the future.
Image source: Getty Images.
This is another reason why I’m soft on Robinhood stock. Net interest income currently accounts for nearly half of the company’s total revenue, and there’s no way to prevent a sharp decline that may be around the corner.
At the end of Q3 2024, Robinhood held $4.4 billion in cash on behalf of its clients, in addition to $4.8 billion in its own cash. That money is stored in selected bank accounts that earn interest. Additionally, Robinhood currently earns interest on the $6.8 billion in margin loans it uses to purchase stocks and other financial assets.
Between March 2022 and August 2023, the Federal Reserve hiked the federal funds rate (overnight interest rate) from 0.1% to 5.33%. That was great news for Robinhood. Because storing and lending money is a big part of its business.
In the third quarter, Robinhood’s net interest revenue was $274 million. If you recall, that’s about the same as what the company generated from processing client transactions. That could be bad news, as the Fed cut interest rates last September, November, and December, and is expected to do so at least twice in 2025.
In other words, Robinhood’s main source of income is steadily drying up, and there’s little the company can do about it.
Robinhood stock looks very expensive after surging over the past 12 months. It is currently trading at a price-to-sales (P/S) ratio of 18.4. This is more than double the average of 8 when the company went public in 2021.
Food PS ratio data by YCHARTS.
Put another way, Robinhood stock would have to plummet by about 56% to match its long-term average P/S ratio. Alternatively, the company can increase its earnings, which will organically shrink the ratio (assuming the stock can’t climb any further).
According to Wall Street consensus forecasts (provided by Yahoo), Robinhood could generate $3.3 billion in revenue in 2025. This year’s 40% potential downside is in line with its long-term average.
Even analysts are having a hard time justifying the recent surge in Robinhood stock. The Wall Street consensus price target is $41.25, according to Benzinga. This means the stock could sink 17% over the next 12 to 18 months. But it gets worse. The lowest analyst target is $11, suggesting the stock could plummet 78%.
Considering Robinhood’s long-term face, including a shrinking user base and declining interest rates, I think investors should avoid chasing rallies in the stock.
Consider this before buying stocks on Robinhood Markets.
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Anthony di Pizio has no position in any of the stocks mentioned. Motley’s Fool has no position in any of the stocks mentioned. Motley’s Fools has a disclosure policy.
Prediction: One soaring cryptocurrency stock could plummet by 50% (or more).
