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Robinhood just got hit with a pit warning. What is this and why could it be big news for stocks?
Robinhood Markets (NASDAQ:HOOD) shares crushed it last year. The online brokerage that revolutionized free stock trading is up 100% in the last 12 months, compared to 27% returns from S&P 500 index. The company just reported strong overall growth in the first quarter of 2024 and is finally generating healthy profits.
But there’s something hanging over Robinhood’s business that could be a headwind for the stock if things don’t fall in its favor. I’m talking about the recent Securities and Exchange Commission (SEC) Wells Notice, which was withdrawn a few days before Q1 earnings. Here’s what the warning means and how it could affect Robinhood’s business in the future.
Why is the SEC investigating Robinhood?
Although it comes with a harmless name, a Well Notice is a serious event for any company. It is the SEC telling a company that – after undergoing an investigation – it believes there have been violations of SEC rules and regulations by that company. The SEC notifies a company through a Wells Notice to give it time to respond to these allegations before going through the entire legal process.
The SEC is investigating Robinhood and on May 4 issued a warning from Wells to Robinhood that he believes SEC rules were violated. About what, you may ask? Your cryptocurrency business. Shocking, I know. Robinhood Crypto is being cracked down on for its cryptocurrency listings and the way it operates its crypto trading platform. It’s unclear exactly what laws the SEC believes Robinhood has violated, but it could lead to fines, settlements, and even a ban on some of its current crypto offerings for customers.
Earnings were strong, but we need to take a closer look at what drove the growth
Robinhood shares didn’t change much after this report came out. In fact, it’s still up 40% year to date. First-quarter earnings were released this week, with the company reporting strong growth across all of its businesses.
Total net revenue grew 40% year over year to $618 million in the quarter, driven by $126 million in crypto revenue (growing 232% year over year) and $254 million in interest income. Robinhood also makes a good chunk of its money from options trading, generating $154 million in options revenue in the first quarter. The bottom line profits are also finally starting to show. Net profit was $157 million in the first quarter, a significant improvement over recent years of losses.
From my perspective, there are two main concerns with Robinhood’s earnings. First, it is earning $254 million of its $618 million in revenue from interest income from customer deposits. If the Federal Reserve cuts interest rates, these profits will face a headwind. It is also highly competitive for financial platforms to encourage customers to keep their money with them. For example, Robinhood Gold subscribers earn a 5% interest rate on their cash balances, which is slightly lower than what Robinhood can earn by investing available cash in short-term U.S. Treasury bonds.
The story continues
Robinhood’s crypto revenue grew 232% last quarter to $126 million. With Wells’ warning imminent, this recipe is in danger of disappearing completely. We don’t know what the outcome of this SEC investigation will be, but it’s possible that Robinhood will be banned from offering cryptocurrency trading on its platform or face a large fine for any laws it has violated. This could be another obstacle for the shares to advance.
HOOD Total Return Level Chart
Is Robinhood Stock a Buy?
There are many risks to Robinhood’s business model. Despite these risks, the shares don’t look cheap. It trades with a market capitalization of $15 billion, generated just $2 billion in revenue over the last 12 months, and trades on a price-to-earnings ratio (PHYSICAL EDUCATION) above 100.
A combination of macroeconomic, regulatory and valuation risks makes a stock like Robinhood a tough buy. At these prices and with the current Wells Warning hanging over the business, investors should avoid Robinhood for now.
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Brett Schafer has 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.
Robinhood just got hit with a pit warning. What is this and why could it be big news for stocks? was originally published by The Motley Fool