It's about time. It may have taken a resurgence in interest in meme stocks like GameStop (GME), but the brokerage firm Robinhood (NASDAQ:HOOD) has finally found legs of its own. The company appears to be seeing an acceleration in growth on account of both its new product releases as well as an apparent surge in retail investor interest this year. The company has also seen a lasting boost to its financial metrics from the higher interest rate environment, which in conjunction with committed operating expense discipline has helped the company dance around GAAP profitability. With the bullish thesis in full swing, readers might be surprised to see that I am moving to the sidelines. I am of the view that the current valuation has worsened the risk-reward profile, as the company needs to execute strongly to justify the current stock price. I am downgrading the stock from "buy" to "hold" (representing the close of a bullish rating).

HOOD Stock Price

I last covered HOOD in April, where I rated the stock a buy on account of ongoing momentum from the company's newly released credit card product. The stock has performed strongly since then, trading up 34% versus 7% returns from the broader market.

I have been recommending HOOD stock since May 2022 and waited patiently as the stock essentially stayed in the $8 to $12 range for two years. The stock has finally delivered the alpha I was looking for, perhaps showing that some patience might be needed, especially when there's a lack of investor love for the name.

HOOD Stock Key Metrics

HOOD is a brokerage firm which might have the reputation for catering largely to retail investors. This notion is arguably undeserved given that HOOD can be better described as a leading innovator in the space, with key features such as 24-hour market trading.

HOOD had suffered through many quarters of stagnant growth following the pandemic but appears to have hit an inflection point. Funded customers grew by 500k sequentially, the largest sequential gain since the second quarter of 2021.

HOOD saw assets under custody grow 65% YoY, which was credited to higher asset valuations and growth in net deposits. Recall in my prior report that HOOD appears to have seen an easing of outflows, with management noting that they, in general, have been the beneficiary of any broker-to-broker transfers.

HOOD's success in adding net deposits might be due to the ongoing development of their Robinhood Gold subscription product. HOOD saw Gold subscribers grow 42% YoY and 18% QoQ to 1.68 million. I note that their Gold card (known for earning 3% cash back) was released only in March, and thus did not benefit the company for the full first quarter. I expect the second quarter to see further acceleration in growth due to incorporating a full quarter of the Gold card.

HOOD saw net revenues grow 40% YoY. This was a particularly impressive result given that the company already began lapping tough comparables from an interest revenues perspective, with net interest revenues growing by just 22% YoY.

The company saw transaction-based revenues grow by an astounding 59% YoY, including 44% YoY growth in equity and 232% YoY growth in cryptocurrency trading - retail investors are back!

The company saw adjusted EBITDA more than double YoY, with margins expanding 1,400 bps to 40%. It is notable that the $247 million in adjusted EBITDA was just slightly lower than the $254 million in net interest revenues earned in the quarter. It is clear that management's operating expense discipline is paying off, as its profitability is coming close to no longer being driven solely by the higher interest rate environment.

The company even saw GAAP net income jump to $157 million in the quarter, which was a record for the company.

HOOD ended the quarter with $5.2 billion in corporate cash and investments versus no corporate debt. This net cash position is less significant from a valuation perspective after the stock's huge run-up but still represents around 25% of the current market cap.

On the conference call, management noted that 20% of newly funded customers had subscribed to their Gold subscription product, more than double the rate of a year ago - indicating stronger adoption. Some readers might wonder if HOOD's new products are really innovations, given that they seem to be largely promotional measures that in theory should be easy to replicate. I might take the opposite view of that, as HOOD is a clear example of how its digital-first presence allows it to have an easier time offering more promotional products. Management highlighted "cost structure" as a potential reason why competitors might find it challenging to replicate their promotional activity. As an active investor myself with accounts across various brokerage firms, I am of the view that legacy brokerage firms remain too focused on generating profits, especially from fees. I find it possible, if not likely, that legacy firms change their models to allow for promotional activity only after HOOD has taken much market share, when it might be too late to stop the momentum.

Since the end of the quarter, HOOD announced a new $1 billion share repurchase program, which I believe the company is likely to follow through on given the high cash flow generation. The company also agreed to purchase Bitstamp, which may accelerate its entrance into offering cryptocurrency products to institutional customers. I am uncertain about this opportunity, as it bears repeating that outside of this past quarter, cryptocurrency trading revenues were not so significant for the company, and it isn't clear how the institutional space will develop given that spot Bitcoin ETFs have been trading since the beginning of this year.

Is HOOD Stock A Buy, Sell, Or Hold?

After this year's rally, HOOD finds itself trading at just under 9x sales.

This is a good moment to discuss the net cash position and valuations. Back when HOOD traded around $10 per share, net cash made up around 50% of the market cap, leading to an anemic 3x to 4x EV/S multiple. But now net cash only makes up 25% of the market cap, and the stock trades at a 6.7x EV/S multiple. I note that one arguably should not put too much emphasis on the net cash position in valuation, given that much of the revenue base is generated from interest earned on corporate cash.

Is HOOD cheap here? I'd argue that it is not so clear. For starters, close competitor Charles Schwab (SCHW) trades at 6.8x sales, backed by GAAP profitability and a longer history of being able to keep and grow customer accounts. In my prior report, I wrote:

With the stock trading at 7x sales, the stock looks attractively valued, especially given that competing firm Charles Schwab (SCHW) trades at 6.5x sales itself. I can see HOOD sustaining at least double-digit top-line growth for many years, which could justify an 8x to 10x sales multiple (equating to a 24x to 33x earnings multiple based on my long-term 33% net margin assumption), implying solid upside between ongoing growth and multiple expansion potential.

With HOOD already trading within my 8x to 10x target valuation, we must reassess the value proposition. At a 33% net margin assumption, HOOD is trading at around a 27x long-term earnings multiple. As growth matures, I expect HOOD to trade more around the 15x to 18x earnings multiple range. This would better reflect the ever-present risk of customers fleeing to competing platforms, as the digital age has made account transfers much easier than in the past. I also note that SCHW and Interactive Brokers (IBKR) currently trade at around 18x to 22x earnings, and I view these two names to be among the highest-quality names in the brokerage space. The high end of that fair value range implies a 6x sales multiple. If HOOD can sustain 20% top-line growth for many years (3 to 5 years), then the stock might still be cheap here. But absent a sustained acceleration in top-line growth, the current valuation does not look supported by the fundamentals, as it may be pricing in too much growth. I need to see more evidence of HOOD being able to grow and keep assets under custody through investment cycles before I can become more comfortable with both the growth story as well as a higher long-term target valuation multiple.

HOOD Stock Conclusion

There might still be upside ahead for HOOD stock, but the company may need to show stellar financial results in order to allow for those scenarios. The company is profitable and growth is inflecting upward, but I am concerned about the valuation. I am not so confident in HOOD being able to generate at least 20% top-line growth over the next 3 to 5 years, making me less confident in the current stock price. I am downgrading HOOD stock to "hold," representing a neutral rating (and close of my prior bullish calls).