Robinhood: What to Know Before It Goes Public
A look at how the trading app makes money, its competition, and its growth potential.
Robinhood has been no stranger to the spotlight since the launch of its trading platform in 2015. The company has been a disruptor in the fintech space: The discount brokerage’s mission to democratize investing, its streamlined platform, and zero minimums have made it popular among younger investors. Its no-commission model has forced competitors to follow suit.
Robinhood’s growth has been impressive, and the company has found no shortage of funding. One of Robinhood’s co-founders told members of Congress in February that the brokerage has more than 13 million users. JMP Securities estimated that Robinhood’s total accounts may actually be closer to 23 million. Through January 2021, the company has raised nearly $5.6 billion. After its last deal, Robinhood’s post valuation was $11.87 billion, according to PitchBook, a Morningstar company.
While Robinhood has an impressive funding history in the private market, going public can give the company access to even more capital to fuel future innovation and growth. On Tuesday, Robinhood confirmed that it had confidentially filed for IPO. Despite recent hubbub, a spike in demand for pre-IPO shares suggests that the company’s valuation could approach a whopping $40 billion, though that estimate is likely overly optimistic.
In March of 2020, Robinhood’s trading platform crashed during a period of extreme market volatility, leaving users unable to make trades without a customer service line to call. The outage was particularly painful given how fast the average Robinhood user trades; Robinhood users trade riskier securities--at a faster pace--than those of any other retail brokerage.
In addition to congressional questioning, Robinhood has also come under regulatory scrutiny. In findings published in December 2020, the U.S. Securities and Exchange Commission stated that Robinhood had previously failed to disclose its largest source of revenue: payment for order flows. The SEC also found that Robinhood had sacrificed price improvements for its customers (a potential benefit of outsourcing customer orders to principal trading firms) in the name of higher revenue. The SEC fined Robinhood $65 million.
Here are Robinhood’s main sources of revenue.
Payment for order flows makes up the majority of the company’s revenue. These payments mean that Robinhood benefits from more trades. The platform itself seems to encourage high-frequency trading. Among the different securities that users can purchase, Robinhood benefits the most from options, which are generally riskier than traditional stocks.
As more users joined Robinhood and trading volume increased in 2020, Robinhood’s revenue from order flows jumped from $91 million in the first quarter to $180 million in the second quarter. Order-flows payments brought in $682 million in revenue for the year.
Robinhood competes with a bevy of discount brokerage platforms offered by both public and private firms. Many of these companies also offer more-traditional brokerage options in addition to online platforms for do-it-yourself investors. Many also have an array of revenue streams from business segments that are separate from their retail brokerages altogether.
Charles Schwab (SCHW), TD Ameritrade (acquired by Charles Schwab), E*Trade (acquired by Morgan Stanley (MS)), Fidelity Investments, and Interactive Brokers (IBKR) stand out as some of the most widely used discount brokerages in the United States. Pressured by Robinhood’s growing popularity, these firms eliminated stock-trading fees for online trades in 2019.
Though both Charles Schwab and TD Ameritrade took a hit when they slashed their commissions, Morningstar equity analyst Michael Wong views Charles Schwab-TD Ameritrade as a financials-sector powerhouse. The combined firm has more than $5 trillion of client assets. While Robinhood has managed to attract more users to its platform than Schwab, the average Robinhood account holds $5,000, compared with roughly $240,000 at Charles Schwab and $110,000 at TD Ameritrade.
In addition to its scale and cost efficiency, Wong sees an advantage in Schwab’s investment offerings: “We estimate that around 25% of client assets are in either a Charles Schwab proprietary or a controlled product, which allows the company to extract more profits on client assets than other brokerages where their clients use primarily third-party products.”
According to PitchBook, Robinhood is part of the “wealthtech” segment, which consists of companies that provide alternatives to traditional wealth-management services. PitchBook analyst Robert Le believes companies in this space have opportunities “to attract new assets from customers who expect digital, usercentric, and multichannel solutions to manage their assets.”
Pitchbook analysts have identified three primary drivers of the wealthtech industry that stand to benefit Robinhood.
Robinhood may prove that all publicity is good publicity--after all, there’s no denying that the discount brokerage has become a household name. Despite media backlash, Robinhood has continued to grow its user base at an impressive rate.
Margaret Giles does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.