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Robinhood may have revolutionized online stock trading, but that doesn't mean you should buy Robinhood stock once it goes public.
Today, we'll break down the case for jumping headfirst into the Robinhood IPO. Plus, we'll also show you how Robinhood's emergence is creating a money-doubling opportunity on another stock.
The rumors circulating around a Robinhood IPO date as far back as 2018. In September 2018, Robinhood's CEO, Baiju Bhatt, told TechCrunch the firm was preparing for an initial public offering (IPO). And the firm has endured audits from the Financial Industry Regulatory Authority, the U.S. Securities and Exchange Commission, and its own security team to make sure it exceeds security standards for when it does.
This is big news considering the company was mostly unknown until 2017. And especially considering it put companies like TD Ameritrade Holding Corp. (NASDAQ: AMTD) and Charles Schwab Corp. (NYSE: SCHW) on the defensive.
Robinhood took online brokerages by storm by offering zero trading fees and no account minimums.
Now, Robinhood has become a real contender for one of the best online trading platforms, with a booming valuation of $7.6 billion. And with so many people waiting in anticipation to invest in the firm, its valuation could soar to even greater heights at its IPO.
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But even with its insane potential and the excitement surrounding it, you may not want to buy Robinhood stock immediately following its IPO.
Let's take a look at how Robinhood got its incredible $7.6 billion valuation - and why that might not be enough to buy it on its IPO date...
How Robinhood Got Its Start
Roughly a decade ago, co-founders Baiju Bhatt and Vladimir Tenev were both classmates and roommates at Stanford University.
Once they graduated, they packed up and moved to New York. Within two years, they had built two finance firms that sold trading software to hedge funds.
But during their time in New York, they noticed something unsettling. The big companies on Wall Street paid next to nothing to trade stocks on the market, while everyday folks were charged as much as $10 per trade.
After realizing this, they saw an opportunity to create a platform that could give everyone a chance at investing in the market, and not just the hyper-elite.
After two years in New York, the co-founders made their way back to California and started what would eventually become Robinhood.
Initially, investor sentiment was cold. The two had met with 75 potential investors, and all of them were skittish over funding a trading platform that had zero fees.
But the two continued to hustle. And eventually, a few investors, like Serik Kaldykulov, saw the potential in Robinhood.
By 2013, Robinhood launched with $3 million in venture capital, according to US News. And within the first 30 days, the trading platform had accumulated over 100,000 users.
It's been almost seven years since then. But in that time, Robinhood has built up an active user base of more than 6 million people. Beyond that, it has become a trading platform powerhouse with a valuation of $7.6 billion.
The firm has even received investments from big-name celebrities like Jared Leto, Jay-Z, Snoop Dogg, and Nas.
Now, Robinhood has garnered the attention of Venture Capital firms like Sequoia Capital as well. And it's become a private company that many analysts see a great deal of potential in.
And here's why...
Robinhood's App and Finances
Initially, Robinhood set out to challenge traditional trading platforms. US News reports that for close to 200 years, big brokers charged fixed-rate commissions. Even back in the 1970s, some trades could cost investors hundreds of dollars.
Of course, by 2014, trading fees dropped to anywhere from $5 to $8 per trade for major platforms like Fidelity National Financial Inc. (NYSE: FNF) and TD Ameritrade. But that was still expensive for the average trader, especially if you were only buying or selling a small number of shares at a time.
Robinhood saw an opportunity. The company said that even these lower fees were still gouging everyday folks for their money while the hyper-wealthy paid next to nothing.
Instead, they created a free and simple trading platform. Through Robinhood's mobile app (available for Android and iOS), folks can easily deposit money and start investing from their smartphones with zero fees.
Robinhood has a sleek, barebones user interface that makes it perfect for novice and tech-savvy investors alike. In fact, that's the demographic Robinhood is going after - young, tech-savvy investors interested in playing the market, but who don't need all the complexities you'd find with full-service brokerages.
But if you want even more services, you can sign up for Robinhood's $10-a-month Gold premium service. This enables users to transfer $1,000 into their account instantly, rather than waiting for the standard five-day verification period.
Plus, Robinhood incentivizes its users to invite people to use the app by offering a free stock for each person they get to sign up. And Robinhood has branched out beyond traditional stocks and now offers options trading, cryptocurrency trading, and FDIC-insured cash management accounts.
According to Crunchbase, this has helped Robinhood raise about $862 million since 2013 and has launched its valuation up to $7.6 billion.
While all of this makes the firm sound like it's living up to its name, there's a bit more going on under the hood. In fact, one of the biggest driving factors behind Robinhood's growth is a controversial practice...
Robinhood's Controversial Business
Robinhood's platform doesn't charge a per-trade fee to its customers, but that doesn't mean customers aren't paying for their trades.
This is thanks to Robinhood selling its users' orders to high-frequency trading firms like Virtu and Citadel Securities, according to CNBC.
While Robinhood says the practice is benign, it's made the company a lot of money.
A report by Alphacution says the firm's order flow revenue rocketed 227% to $69 million in 2018. That's supposedly 40% of the firm's total revenue for the year, as recorded in the report.
Here's how it works.
Since high-frequency traders know you're buying shares, it's likely they'll end up charging you slightly more for each share. So there's a good chance you're paying a higher price than you would on another platform. And even though it might just be pennies or a fraction of a penny, it adds ups, especially on larger orders.
In the end, the trades appear to be free, but you're ultimately paying for them in other ways, and Robinhood is getting a cut.
This has those watching the company raising their eyebrows.
But controversial practices aren't the only thing weighing against the Robinhood IPO...
Robinhood Is Competing Against the Biggest Brokerages in the World
Since 2013, Robinhood has been competing against financial powerhouses that have been around for decades.
It was able to turn the only trading market on its head by catching these big players off guard. But these firms have already made moves to match Robinhood's business model.
These finance giants include firms like Fidelity, TD Ameritrade, and Charles Schwab.
Both TD Ameritrade and Charles Schwab have begun offering free trading, rivaling what made Robinhood unique in the first place. And these firms make billions in pure profits. They've practically solidified their places as the top brokerages and have a nearly boundless amount of resources to combat the competition.
Even with Robinhood's surge in popularity, it doesn't even bring in a fraction of what these bigger firms do.
If we use Alphacution's report, which said Robinhood's $69 million from high-frequency trades made up 40% of its total 2018 revenue, then the firm made around $172.5 million last year.
To put that into perspective, both TD Ameritrade and Charles Schwab saw over $5 billion and $10 billion in revenue, respectively, in the same year.
Of course, these two firms have almost 50 years of brand recognition over Robinhood. But it means Robinhood is facing an uphill battle, and it may have already peaked. Robinhood's IPO could easily be the company trying to cash out before its revenue takes a hit from the big players fighting back.
But controversy and competition aren't the only things to think about when eyeing the Robinhood IPO...
Why We're Skeptical of Investing in Robinhood Stock at the IPO
Despite its potential, investing in Robinhood stock at the IPO will be risky for everyday folks.
First, because Robinhood is still a private company, almost all of its financials are under a tight lock and key.
We don't know whether it's bleeding money or raking in profits. So, until the Robinhood IPO date is officially announced and we see its last two quarters of financials leading up to it, we can't confidently recommend investing in Robinhood stock until we know more.
But IPOs typically disadvantage everyday people, too.
The only ones that truly profit are angel investors, venture capitalists, and big banks. Angel investors can buy shares when the firm is in its infancy and cash out at the IPO. Banks and venture capitalists can buy millions of shares before the IPO or at a discounted price before it starts trading publicly.
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Plus, 2019 has been a rough year for IPOs, despite it being one of the biggest IPO years yet. It could be a sign unicorn companies are cashing in while the hype is still high.
Just look at how hyped-up companies like Lyft Inc. (NASDAQ: LYFT) and Uber Technologies Inc. (NYSE: UBER) tumbled following their IPOs. They're both down 18.8% and 43.7%, respectively, from their first day of trading.
It's a sign companies are rushing to market as a payday and not because it makes the most financial sense.
That's exactly why we can't recommend buying Robinhood stock at its IPO, especially not before we have a better idea of what its financials look like and how it could perform once it's trading publicly.
But that doesn't mean you can't still profit from the online trading industry. In fact, we have one major trading firm that already plays a vital role in the market. And it just received a high rating from our Money Morning Stock VQScore™ system
That means it's poised for breakout potential.
Our estimates show this stock could shoot up more than 100% higher.
And you don't have to wait on a risky IPO either...
The Best Alternative Play to Robinhood Stock
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E*Trade Financial Corp. (NASDAQ: ETFC) offers everything Robinhood does, and it's already proven to be profitable. Plus, the stock is ready for a breakout.
E*Trade is a financial services company that offers an online trading platform for folks to trade stocks, futures, ETFs, mutual funds, fixed income statements, and options.
What makes E*Trade such a great alternative play is the fact that it's been a pioneer for discount brokerages for 37 years. It was also one of the earliest movers for online trading. It was Robinhood before Robinhood.
Since it's been around for a long time, E*Trade is great at delivering a variety of services that go beyond what you'd expect from a "discount" broker. It's often praised for its educational tools, robust desktop and mobile platforms, as well as its customer service.
And more recently, it's become yet another big brokerage offering free online trading along with its more in-depth services. That takes the wind right out of Robinhoods sails.
Plus, the firm's 2018 financial report showed revenue of $2.87 billion. And its current trailing twelve-month (TTM) revenue is $2.94 billion.
To put that into perspective, the media has been recently touting Robinhood's feat in surpassing E*Trade in its number of users. And while that seems like a pretty big deal, the fact of the matter is that E*Trade's revenue with 3.7 million users was still 1,569% higher than Robinhood's estimated revenue with 6 million users.
So, not only is it making a boatload more cash than Robinhood, but it also has a leg up on this up-and-coming competitor with its years of experience and features.
But much like Charles Schwab and TD Ameritrade, E*Trade trended downward in late 2018 following Robinhood's market disruption. But now that E*Trade has begun to close the gap by offering free trading as well, the competition is bound to heat up.
Beyond that, E*Trade has a long track record of profitability. In fact, E*Trade has turned a profit every year since 2012. This year alone, the firm raked in $1.053 billion in pure profit.
Right now, E*Trade's fiscal year EPS estimate is $4.14. Nasdaq reports that between now and 2022, the company's EPS is expected to grow to $4.55 per share.
This means Wall Street thinks it'll continue to increase its profits. And it's no surprise, considering it's a pioneer for online trading and it has a track record of profitability in a highly competitive market.
That also means the stock is trading way below what it should be. And with a VQScore of 4.8, it won't be this cheap for long.
E*Trade currently trades for $42.56 per share. With a price/earnings (P/E) ratio of 10.28, this stock is highly undervalued compared to its sector's average P/E ratio of 19. And E*Trade has traditionally traded at a valuation in line with its industry. Its average P/E ratio over the last five years is 21.44.
We expect E*Trade's valuation to return to normal soon. If it were to grow enough to hit the industry average, its share price could gain 84.6% to $78.66.
If you consider its five-year P/E ratio of 21.44 before Robinhood swooped in, it could potentially shoot up 108.6% to $88.86 per share.
That's an excellent gain without having to risk buying in during an IPO.
But if you're looking for even greater potential returns, you don't need to hedge your bets on IPOs anymore.
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About the Author
Daniel Smoot is a Baltimore-based editor who helps everyday investors with stock recommendations and analysis. He regularly writes about initial public offerings, technology, and more. He earned a Bachelor's degree from Towson University.