The favorable market environment has benefited many businesses. Just look at Robinhood Markets (NASDAQ: HOOD). As of Friday, its shares have risen more than 40% year to date.
But zoom out and it’s a totally different picture. The fintech stock is currently trading about 70% below its all-time high. Clearly, a lot will need to go right for Robinhood for its market cap to get back to its high-water mark.
Investors who might be eyeing this beaten-down growth stock as a way to ride the recent momentum will want to understand more about Robinhood’s business model. You might be surprised at how the company makes a significant chunk of its revenue.
Thank you, Federal Reserve
Most people know Robinhood as a low-cost online brokerage service. Its 10.9 million monthly active users (MAUs) use the platform to buy and sell stocks, options, and cryptocurrencies, providing it with transaction-based revenue. This was the source of 42% of its revenue last year.
You’re probably wondering how else Robinhood makes money. All the attention goes to net interest revenue, which totaled $929 million in 2023, half of the company’s total and up 119% from 2022. Back in 2021, when the benchmark federal funds rate was still near zero, net interest revenue made up just 14% of Robinhood’s top line.
This interest is earned from the cash on the company’s balance sheet, client funds held in their accounts, and customers’ credit card balances. When interest rates are high, Robinhood enjoys a nice windfall for doing absolutely nothing. Without this critical revenue source, the company would not have reported positive net income in Q2 or Q4 last year.
The executive team should be thanking the Federal Reserve. As part of its efforts to curb soaring inflation, the central bank embarked on a path of aggressive hikes to interest rates starting in March 2022. That has benefited Robinhood tremendously.
Not on a sustainable path
This recent development of higher interest income worries me. It’s not core to Robinhood’s business — the company’s bread and butter is facilitating market transactions for its users. Investors need to realize that the growth of this revenue isn’t sustainable.
To be fair, though, inflation is proving to be a bit stickier than anticipated. While it’s far below its mid-2022 peak above 9%, it was still 3.5% in March — and the Fed wants to get it down to about 2%. So the central bank might have to wait before it starts to cut interest rates, an action that analysts and economists are waiting for with great anticipation. But if history is any indication, interest rates will likely come down at some point in the future. We just don’t know when exactly. The U.S. government has $35 trillion in debt outstanding, and it ran a $1.7 trillion deficit last fiscal year, both of which make lower rates very desirable.
This means that the economic situation that has provided a major boost to Robinhood’s finances will eventually come to an end. That’s troubling because it points to a more fundamental issue: The company’s success is strongly influenced by factors outside of its control. No bank or executive team has any say over what direction interest rates are going in. This adds uncertainty to Robinhood’s operations and financial picture.
Additionally, the business is fully exposed to the unpredictable performance of various assets. In theory, rising asset prices will lead to increased interest from people who want to invest. Robinhood provides a fantastic user experience for doing just that, so during a bull market, it should be able to sign up more customers who will also trade more often.
However, I find it worrying that in 2023, in the midst of a bull market, Robinhood posted a 4% annual decline in transaction-based revenue. And the company’s MAU base at the end of 2023 was smaller than it was 12 months before.
These concerning indicators should make you think twice about buying shares.
Should you invest $1,000 in Robinhood Markets right now?
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Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
You Wouldn’t Believe How This Beaten-Down Growth Stock Makes Money was originally published by The Motley Fool