Now that the app-based brokerage firm, Robinhood, has gone public I wonder if it will become a meme stock itself. Will it become a trending topic on Reddit? Will it experience significant price changes over short periods of time with no news? Will it experience a market value completely decoupled from its fundamentals? It seems like the answer to all of these questions could be “yes”.
The Fundamental Risks of Robinhood
Based on its S-1 filing, Robinhood appears to be more of an investing casino than a brokerage firm. As with all casinos, the house can only make money so long as people come to play. That is all fine – until people get burned. When we get burned, we tend not to play.
Robinhood has experienced explosive growth over the last few years, and many of their new accounts are new “investors”. I put “investors” in quotes because Robinhood users act more like speculators than investors. Roughly half of Robinhood users login daily and those individuals look at it, on average, seven times per day. Those are not characteristics of investors; those are speculators focused only on price movement. And we know that speculating is not a long-term endeavor for many people. The party can last for a while, but eventually most speculators learn a costly lesson. They get burned.
A significant risk for Robinhood comes from where they derive their revenues. 47% of transaction-based revenues came from options in 2020. While some options are used to hedge, given the underlying behavior of Robinhood users, we can surmise that many of these option transactions are speculative bets on price movement. That’s not it. A “substantial portion” of recent revenue growth came from trading in the meme cryptocurrency, Dogecoin.
In other words, much of Robinhood revenue relies on the speculative behavior of their users.
Hints of 1999
This reminds me of 1999. Many new participants entered the market to “invest” in technology stocks. The question wasn’t whether a technology stock would double, it was how quickly. People quit their jobs and day trading firms popped up across the United States. It was exciting for a while. The day traders would make a year’s salary in just a few weeks – and made sure the entire world knew about it. And then it ended as quickly as it began.
Robinhood has the same kind of feel. I wonder what will happen in the future. Will the stock defy fundamental gravity and soar as other meme stocks based on chat boards and hype? Will it become heavily shorted and lose significant value, putting at risk its ability to remain in business? And will its stock price impact the trading of other speculative securities and the financial livelihood it depends upon?
This one will be a fun story to track. I don’t know what lessons will come of it yet, but my guess is that sometime in the next year whatever happens will become part of my behavioral finance presentations.
Related: The Peril of “Expert Forecasts”