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Over the past year, retail investors have flocked to mobile trading apps to go public, but Robinhood Markets (NASDAQ: HOOD) and its well-known trading app have had a rough 2021 so far. Here are four reasons why investors should avoid this recent IPO.

1. Robinhood uses a risky trading strategy to make money

Options can be difficult for new investors to understand and in some cases come with unlimited risk of financial loss. In the first quarter of 2021, options represented 38% of Robinhood’s revenue; on each option trade, the site earned $ 2.90, compared to $ 0.40 on each stock trade.

Robinhood’s sizable gains from options betting prompt him to push inexperienced investors to trade these risky stocks – and potentially lose their entire investment on a single trade. This is a risky trading strategy for Robinhood users, especially since the company has yet to weather the bearish market conditions.

Image source: Getty Images.

2. The company has not had the best start since going public

In its first two quarters, Robinhood posted mixed financial performance. Year-to-date, the company has reported a net loss of $ 1.9 billion and has total liabilities of $ 17.9 billion. Much of this is because the company had $ 3.5 billion in debt that it raised in emergency financing in February 2020. Its positive operating profit of 122 , $ 9 million to date is absorbed by more than $ 2 billion in spending from its convertible bonds and bonds. Although Robinhood has increased her income, she is over-leveraged and will need to increase her income growth to reduce her high debt-to-income ratio of 40.6 and justify her share price.

3. He had major problems with the SEC

Robinhood offers a “zero commission fee” on every transaction, but it continues to make money on every transaction using a taboo practice called “pay-to-order flow” (PFOF).

When its clients carry out a transaction, Robinhood acts as an intermediary or broker. He trades with resellers or wholesalers, who own shares of many different stocks, to receive a reduction in the bid / ask spread – the difference between what the person at one end of a stock trade is willing to sell for. that share, and how much the person on the other end of the trade is willing to pay to buy it. The greater this difference, the greater the reward for Robinhood and the wholesalers, even if it means that customers end up paying more than they might have at another brokerage to buy the same stock.

Robinhood may not charge its customers a fee up front, but by collecting a share of every transaction they make, it charges them higher prices behind the scenes. Further, it presents a conflict of interest for Robinhood to put its partnership with wholesalers ahead of its duty to investors.

The SEC condemned the practice and fined Robinhood $ 65 million for misleading clients about how it generates income, as well as an additional $ 70 million for its poor selection of inexperienced investors interested in options trading. It could take years for Robinhood to regain the confidence its investors have lost as a result of these convictions.

4. Robinhood broke public trust

Robinhood has had a roller coaster year, with many topical transgressions. In January, Robinhood halted trading after retail investors began buying and selling shares of GameStop. It angered investors who lost money on halted deals, and the Reddit community took to social media and angered the public, with users asking CEOs to step down.

In the same year, a teenage Robinhood user committed suicide, fearing he would go into massive debt because of his unsuccessful option trades. Robinhood’s app makes stock trading more like a game, which critics blame for contributing to the very risky trades of inexperienced investors and the resulting losses. Public acrimony towards Robinhood limits its ability to build relationships with new users; in a February 2021 survey, nearly 56% of account holders were considering leaving the app.

Despite the above reasons, not everything is going wrong for Robinhood. It increased its revenue by 131% from last quarter and increased its share of cryptocurrency revenue from 17% to 51%. In fact, he made $ 233 million from crypto trades in the second quarter, more than half of all transaction-based revenue of $ 451 million for that period. However, cryptocurrencies fluctuate widely and risk being regulated by the government, making their importance to Robinhood’s revenue a great vulnerability for the business.

Additionally, Robinhood’s massive debt remains a huge issue the company has yet to resolve. In August 2021, Robinhood announced its intention to acquire Say Technologies, which makes it easy for smaller shareholders to ask questions about the companies they invest in. While this addition may help Robinhood improve its customer experience, M&A deals are risky, adding $ 140 million to the company’s already massive debt. With a heavy reliance on cryptocurrencies and a large amount of debt, investors should be wary of Robinhood.

Why Robinhood misses the mark

Robinhood has certainly left its mark on the investment community and increased access for retail investors, but it should always be avoided by investors due to its risky business strategy, mixed quarterly results, regulatory concerns and its corporate governance. Despite the strength of its brand, Robinhood is a risky investment and comes under intense scrutiny from public and regulatory entities. Many users have become frustrated with the trading platform over the past year, and they have looked for alternatives such as Charles Schwab and eToro.

Investors should keep an eye out for any headwinds the company has predicted over the next three months. Less business activity in the industry can result in lower income and significantly fewer newly funded accounts. I believe that Robinhood, while well intentioned, has failed to “democratize finance for all” which makes it a risky move for investors.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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