2 Big Reasons to Be Skeptical About the 269% Surge in Robinhood Stock Over the Past Year

Robinhood Markets (NASDAQ: HOOD) has sent investors on a rollercoaster ride since going public in 2021. Its stock listed at $38 per share, soared to a record high of $85, and then plunged by 91% to an all-time low of around $7 -- all in less than a year.

Shareholders were bullish on Robinhood's ability to attract young, first-time investors to its trading platform, where they can buy and sell stocks, options, cryptocurrencies, and more. However, since many of those clients make risky short-term bets as opposed to long-term investments, they tend to flock to the platform when markets are rising, only to leave during challenging times (like in 2022).

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Trading activity is soaring right now thanks to the raging bull market in everything from stocks to cryptocurrencies. As a result, Robinhood stock is up by a whopping 269% over the past 12 months. However, there are two key reasons investors should be concerned.

1. Déjà vu: Cryptocurrency trading is driving Robinhood's revenue growth

Robinhood generates revenue in two ways. First, it earns commissions when clients buy and sell stocks, cryptocurrencies, and other financial assets, which is known as transaction revenue. Second, it earns interest on the cash it holds on behalf of its clients, and also from its margin lending business. This is called net interest revenue.

Since transaction revenue comes from Robinhood's core business operations, it's the more important figure to watch. During the fourth quarter of 2024 (ended Dec. 31), it soared by 184% year over year to a record high of $672 million. However, more than half of that came from processing cryptocurrency trades, which contributed $358 million in transaction revenue. That was up by an eye-popping 733% compared to the year-ago period.

Robinhood has been here before. During the second quarter of 2021, its cryptocurrency transaction revenue soared by 4,560% year over year to $233 million. It was driven by euphoric conditions in the crypto markets that weren't so different from today, with Bitcoin currently near a record high, and popular speculative tokens like XRP and Dogecoin logging big gains over the last 12 months.

Here's the bad news: One year later, in Q2 2022, Robinhood's crypto transaction revenue had plunged by 75% to just $58 million. That coincided with the 91% collapse in Robinhood stock.

I think there is a serious risk of a similar decline over the next year. Robinhood's Q4 2024 result was propelled by President Trump's U.S. election win in November, because he campaigned on a series of pro-crypto policies which triggered a buying frenzy among investors. However, many popular tokens have already reversed course. XRP is down 22% from its recent high, Dogecoin is down 48%, and Shiba Inu has plummeted by more than 50%, which is likely to dampen investors' enthusiasm.

Image source: Getty Images.

2. Interest rates are declining steadily

Robinhood's net interest revenues came in at a record $296 million in Q4, which was a 25% increase from the year-ago period. The company earned interest on the $4.7 billion in cash it was holding for its clients at the end of the quarter, and it also earned interest on its own cash reserves of $4.3 billion.

Robinhood also charges interest when it lends money to clients so they can buy stocks and other securities. During Q4, the balance of its outstanding margin loans soared by 126% year over year to $7.9 billion.

The growth in client deposits, combined with the sharp increase in margin loans, seemed to offset the three interest rate cuts executed by the U.S. Federal Reserve since September. But the company is fighting an uphill battle. Clients typically ramp up their deposits and take out margin loans during periods of extreme bullishness in the markets, and history shows that those don't last forever.

As a result, Robinhood's net interest revenues are likely to start shrinking in the near future, especially since the Fed is expected to continue cutting rates this year. For some perspective, the company was generating around $60 million in net interest revenues per quarter during 2020 and 2021, when interest rates were near zero.

I'm not suggesting revenues will fall that far, primarily because interest rates are unlikely to head back to those historic lows. However, it highlights how much room there is for potential downside from the current level.

Robinhood stock could be poised for a sharp correction

The 269% gain in Robinhood stock over the past year has catapulted it to an incredibly expensive valuation. It trades at a price-to-sales (P/S) ratio of 16, which is almost double its long-term average of 8.2.

HOOD PS Ratio data by YCharts.

In other words, Robinhood stock would have to sink by 48% from its current level just for its P/S ratio to trade in line with its long-term average -- unless, of course, the company continues to grow its revenue.

According to Wall Street's consensus forecast (provided by Yahoo! Finance), Robinhood could grow its revenue to $3.7 billion during 2025, but that places its stock at a forward P/S ratio of 12.3 -- which is still far above its average.

As a result, considering some of the headwinds Robinhood is facing, buying its stock at the current level isn't the most attractive proposition.

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Anthony Di Pizio has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Bitcoin and XRP. The Motley Fool has a disclosure policy.