With trailing 12-month returns of over 200 percent, online stock brokerage Robinhood (NASDAQ:HOOD) has been one of the best financial technology stocks to own during the stock market surge of the last year.
These massive gains, however, may have stretched Robinhood’s valuation and pushed it to the point of overvaluation. Is Robinhood stock overvalued now, or can the business’s strong growth justify the gains shareholders have seen in the last year?
How High Has Robinhood’s Valuation Gone?
When looking at its valuation metrics, it’s not hard to see why some observers believe that Robinhood stock has become overvalued. Shares of HOOD now trade at 44.5 times trailing 12-month earnings, 23.1 times sales and over 131 times operating cash flows. Though high P/E ratios are far from unusual for young, fast-growing businesses like Robinhood, the current ratio is well above where the stock traded late last year and early this year during an earlier phase of its earnings growth.Â
Although analysts are fairly bullish on Robinhood overall, it’s important to acknowledge the extremely wide range of price targets that have been set on the stock. The average price target for HOOD is $150.41, suggesting an upside of about 40 percent from the last price of $107.30.
The range of targets, however, runs from as low as $86 to as high as $180, implying results anywhere from a nearly 20 percent downside to an upside of almost 68 percent. While ratings lean toward a buy, HOOD currently has 12 buy ratings, seven hold ratings and two sell ratings.
What Will Spark Robinhood’s Growth?
Given its premium price tag, it’s clear that the market is pricing significant forward growth into HOOD. As such, the question of whether the stock has become overvalued largely hinges on the growth catalysts that could push Robinhood’s earnings up over the next several years.
The first of these catalysts is the organic growth of Robinhood’s brokerage business itself, which has proven to be highly lucrative. In Q3, for example, transaction revenue increased 132 percent from the year-ago quarter to a total of $730 million. This was accompanied by a 66 percent increase in interest revenues, which rose to $456 million.
Robinhood also plans to broaden its portfolio of financial services with private banking services that include estate and tax planning. Though it remains to be seen how successful this effort will be, the decision to get into a broader range of financial services could help Robinhood diversify its business and follow the path successfully taken by other Fintech startups like SoFi.
Supporting growth in investing and financial services overall is the fact that Robinhood is deeply popular with younger users who are gradually moving into their prime earning and investing years. With an average user age of about 31, Robinhood has a base of customers who are both digitally savvy and likely to see their earning power increase significantly in the coming years. This will likely not only add to more investing activity at Robinhood but also support the growth of its other financial products.
Another trend that could help Robinhood expand even more is its decision to embrace prediction markets. These markets allows users to bet on the outcomes of specific events, such as interest rate decisions or sports results. Annualized revenue from Robinhood’s prediction market has already eclipsed $100 million, and the increased interest in these markets among customers could drive substantially more growth going forward. Prediction growth remains extremely strong, with October’s number of event contracts reportedly outweighing the total number of contracts in all of Q3.
Robinhood bulls also point to its bet on tokenization, or the use of blockchain technology to create crypto-like representations of real-world assets, as a major potential growth driver. Indeed, Robinhood CEO Vlad Tenev has been particularly enthusiastic where tokenization is concerned. Tenev has stated his belief that tokenization will eventually take over the entire traditional financial system, though it remains to be seen how true that will be and how much Robinhood’s early push to lead the way will translate to higher revenues and profits.
Cumulatively, analysts expect these trends to contribute to annualized earnings growth of over 20 percent through the next few years. If Robinhood can maintain this level of growth for five years, earnings per share would reach around $6.15, putting the current price at a little over 17 times expected five-year EPS.
So, Is Robinhood Overvalued?
While there’s little doubt that HOOD trades at a premium, there are several growth catalysts that could help it justify its high valuation. With the business itself already growing at a brisk pace and multiple trends likely supporting that growth going forward, there’s a great deal to like about Robinhood at the moment.
It’s also worth taking Robinhood’s existing quality as a business into account. Trailing 12-month net margin has exceeded 50 percent, while return on equity is over 27 percent. Robinhood also has minimal long-term debt and a significant reserve of cash and cash equivalents that gives it a strong financial footing.
A final consideration is the fact that Robinhood is already using its strong cash position to reward shareholders with significant buybacks. In Q3, for instance, management bought back 1 million shares, bringing the trailing 12-month buyback total to over $800 million. If it keeps up at this pace, Robinhood’s buyback program could gradually concentrate investors’ ownership over several years and contribute to progressively higher per-share earnings.
Overall, HOOD may be pushing the boundaries of fair valuation a bit, but the stock likely isn’t massively overvalued. Instead, Robinhood may be a case of more or less fair valuation for a strong business with significant long-term growth potential.
The high price tag may set Robinhood up for some short-term volatility, a fact that already seems to have shown up in the form of a nearly 20 percent pullback in the past month. In the long run, though, Robinhood may be able to justify its premium price tag and deliver further returns for shareholders who are willing to hold out through volatile periods.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.