Stock Market

Robinhood (NASDAQ:HOOD) stock has significant growth potential over the longer term, but the immediate future is a little less rosy.

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The valuation isn’t stratospheric and the company recently reported impressive second-quarter results.

The problem is that HOOD stock faces risks, particularly in the medium term.

As a result, I do not recommend that investors buy the shares at this point.

I agree with part of Cestrian Capital Research’s take on Robinhood. In an Aug. 20 column, the firm stated that Robinhood can “attract new customers to an old industry.”

Indeed, with its spectacular growth during the novel-coronavirus pandemic, the company has already shown that it knows very well how to attract millennials.

As Cestrian succinctly and correctly noted, Robinhood managed to pull off this feat thanks to “its simple app and website, modern user interface and focus on accounts with relatively small balances.”

Robinhood can use these attributes in the longer term along with its direct access to tens of millions of finance-oriented millennials to effectively enter new financial sectors.

For example, it could seek to get into the insurance business and compete with Lemonade (NYSE:LMND), a new insurer that’s targeting millennials.

Similarly, it could get into banking, where SoFi (NASDAQ:SOFI) has made meaningful inroads with that generation.

Given Robinhood’s huge trove of consumer data and its large financial war chest, I think that the company could take huge amounts of market share in both categories fairly quickly and easily.

Within both the brokerage category and other financial sectors, Robinhood is well-positioned to benefit from a trend that has boosted both Snap (NYSE:SNAP) and Lemonade.

Specifically, as millennial income increases and the group spends more, the revenue of companies that cater to them should climb in tandem.

That catalyst appears to have helped both Snap and Lemonade grow rapidly, and I think Robinhood should also benefit meaningfully from it.

Meanwhile, as many others have pointed out, Robinhood reported very strong Q2 growth numbers on Aug. 18. Its top line soared more than 130% year-over-year, and its monthly active users more than doubled year-over-year to 21.3 million.

Challenges Are Coming

In Q2 more than 40% ($233 million) of the company’s revenue came from cryptocurrencies.

Although my thesis predicting the collapse of cryptos has not yet materialized, “crypto mania” has clearly been on the wane.

Many of the prominent cryptos, such as Dogecoin (CCC:DOGE) and Ethereum Classic (CCC:ETC) seem to have either tumbled sharply recently or, like Bitcoin (CCC:BTC), are trading well within their long-term ranges.

With Congress and the SEC both poised to tighten their regulation of the sector and government stimulus drying up, I expect cryptocurrency prices to tumble in the medium term.

I believe millennials are likely to spend much less money on stocks amid the reopening of economies.

In light of these points, I’m not at all surprised that Robinhood has warned that its growth is likely to slow meaningfully during the current quarter.

Finally, the SEC and/or Congress could very well decide to regulate Robinhood itself more tightly in the medium-to-long term.

The Bottom Line on HOOD Stock

On the one hand, the ostensible forward price/earnings ratio of Robinhood, which stands at 48 based on analysts’ average 2022 earnings per share estimate, is not extremely high or unreasonable.

On the other hand, I fear that the analysts’ EPS estimates do not bake in the full impact of the challenges that Robinhood is facing.

Consequently, when it comes to HOOD stock I would stay on the sidelines until the impact of those challenges becomes much clearer.

On the date of publication, Larry Ramer held a long position in SNAP. The opinions expressed in this article are those of the writer, subject to the Publishing Guidelines.

Larry Ramer has conducted research and written articles on U.S. stocks for 13 years. He has been employed by The Fly and Israel’s largest business newspaper, Globes. Larry began writing columns for InvestorPlace in 2015.? Among his highly?successful, contrarian picks have been GE, solar stocks, and Snap. You can reach him on StockTwits at?@larryramer.?