TIVP045: Robinhood Markets Inc. (HOOD): The World’s Most Innovative Financial Company? w/ Shawn O’Malley & Daniel Mahncke

27:12So I couldn't create an account. And so a year and a half later, before the official launch in 2015, the waitlist had grown to close to a million people. So clearly the concept resonated with a lot of people, including a young version of myself. And by March, 2015, Robinhood had launched on the app store as the first mobile first brokerage in the U S. And as we've already touched on the app was so user friendly that it felt more similar to a social media app than a finance app. And another important element behind the success of Robinhood's initial offering was that there was no minimum deposit required upon registration.

27:50So you could open an account without putting any money in it, which again, was not common in the industry at that time. You know, we talked a lot whenever we covered a payment stock about this industry and how it went to basically commission free trading. So I could just imagine that all the major brokers in the US that have moved to commission free trading, their initial reaction was probably, you know, a lot of panic where all the legacy players were hoping they could just wait it out and just make Robin Hood disappear. How exactly did that go? I think that might be the understatement of the year.

28:22It took a little bit of time as brokers wanted to see if they could outlast Robin Hood and whether this business model was viable in any way. But eventually, Robin Hood's competitors followed their lead and eliminated commissions too. And it was a huge change for the industry that the legacy players certainly didn't consent to, but were forced into. And in 2019, in the span of just a few days, you had Schwab, TD Ameritrade, Interactive Brokers, and E-Trade all announced that they would cut commissions to zero. And at that moment, Wall Street was permanently changed. There was no going back. The cat was out of the bag, as they say.

28:59The culture of innovation, or maybe just a fearlessness of living on the edge would be another way to say it. It seems to have always permeated the company. And all the way back in 2018, Robinhood actually rolled out cryptocurrency to the masses at a time when most had probably never even heard of Bitcoin. Although there was this 2017 mania, I still felt like it was just a little bubble and most people had actually never heard of it. And then in 2019, they introduced fractional share trading, as you mentioned before, which was another huge game changer, allowing small investors to buy fractions of a share.

29:30Because buying even just one share in certain companies can mean an upfront investment of hundreds of dollars and not everyone can afford that. So allowing fractional buying was another way to generally make the stock market more inclusive. Just like you, I started with a broker where I could purchase fractional shares. And I mean, buying even just Berkshire would have been difficult otherwise when I was young, for example. And I'm not, unfortunately, talking about the A shares, but even just the B shares. So the theme with Robinhood seems to be that good comes with at least some bad. commission-free trading and fractionalized shares have objectively just benefited individual investors, well, it's more debatable whether their other features have made society better or worse off.

30:12But the past is the past. And what matters for us is what Robinhood is able to do going forward beyond potentially being, you know, the Amazon Prime of consumer finance. What do you think Robinhood story is basically leading to? I could speculate, but why don't we see what Vlad Tenev has the same self. Here's a clip from him speaking to Behrends in an interview about what the next couple of decades will look like for Robinhood. I think over the next 10 years, Robinhood is going to expand across two independent vectors. One is to go from being U.S. only to global. And we started that earlier this year.

30:53We launched in the UK and European Union. And at our recent investor day, we announced that we've chosen Singapore as our APAC headquarters. So we'll be in Asia next year as well. So from US to global and from consumer retail to also business and institutional. And I think that we've done very well. I mean, some would say Robinhood has changed the brokerage industry in the past 10 years, but our customers want more from us. We see an opportunity to serve different types of customers. And so the ways that I believe we can scale the business another 10x are, there's a multitude of them. And I think we're going to tackle many simultaneously.

31:45I could totally see how they expand geographically, when I compare everything you tell me about Robinhood to the German and even just the European competitors, I think it's just way ahead. I would be a bit worried though about some of its products hindering the move to institutional money. If you're known for gambling and at least to some extent getting into problems with regulators again and again, I think that might be a problem. On the other hand, if Robinhood is where the money is, institutions will probably just follow. So I think there's a lot to get excited about with Robinhood. But before we get into that further, I would love to just understand the current business a bit better.

32:20How exactly, after all, are they able to deliver commission-free trading in the first place? Because if even the legacy players thought they could just outlast them, it isn't that obvious. To your first point, I remember when I told my wife that we had moved a lot of our money to Robinhood, her face might as well turn green, and she said, isn't that risky? I was like, no it's the platform's not risky it's just what some people do on the platform but uh you know don't worry we're we're not gonna make those the same not gonna make those same mistakes but but uh yeah you know to your question of how do they actually deliver on commission-free trading and find a way to do it profitably i mean i have to say kind of honestly understanding better the answer to that question was a big catalyst for why i wanted to dig deeper into robin hood with you so um yeah let's do it i mean some listeners will have heard of this before but the way they do it is through something called payment for order flow.

33:16Essentially, this involves micro scalping of every trade such that any given individual investor is only paying a very small fraction of the cost to trade each time. But that totals up to billions of dollars in costs in aggregate that are going to market makers like Citadel, who are these high frequency traders, And they're the ones paying brokers like Robinhood for effectively the right to front run these trades, basically, or to help complete them. And Michael Lewis has famously used this as his basis for arguing that to some extent, the stock market is rigged, at least on very short term trading horizons.

33:57and that brokers are effectively conspiring against their customers, unnecessarily inserting themselves as middlemen after decades of being more involved previously, even though the computerization of finances has really made it technically unnecessary for there to be any frictional trading costs on electronic orders. And we should probably emphasize that this practice is the focus of intense regulatory scrutiny. It's not guaranteed that this will remain a core part of the business forever. However, intuitively, while the process has seemingly enabled much lower trading costs, there are still costs.

34:33And the way these costs are realized by, you know, selling customer orders to high frequency traders to execute and capture spread on is not exactly a good look. Making me thinking that long term, we shouldn't expect this practice to continue and to be permitted, even if it's functionally many years before any changes actually made. I don't entirely disagree. And I wouldn't be shocked if we eventually saw trading truly become as close to free as possible with payment forward and flow being pushed out by regulators. And then you might think brokers would go back to charging commissions. But I think that's easier said than done.

35:10My guess is that they just accept that trading is a loss leader and try to monetize customers in other ways. But I do think we're talking about a fairly distant hypothetical at this point. Payment for order flow does remain the status quo. Anyways, how payment for order flow works is that brokers receive fees for routing equity trades or really any type of trades to market makers to fill. So for example, if the bid price on a stock is$10.11, that's what somebody is willing to pay for a share, and the ask from a seller is$10.13, cents, a market maker will come in and narrow the gap by giving the retail trader a slightly better price than the public ask quote, and then essentially hedging the other side of that.

35:56They might fill a sell order by purchasing shares from someone at a slight discount. So maybe if a seller wants$10.13, they buy their shares at$10.12, which is a rounding error for most people. And then they turn around and sell those shares to an interested buyer at$10.12.5, reducing the spread between buyer and seller while also pocketing about a half a cent in profit for themselves. And the margins that market makers take on bid-ask spreads are actually smaller than the example I used. But if we get any smaller, it's harder to communicate. So I think you get the idea. Half a cent or less, usually less, times thousands or more likely millions of shares that are trading every day, five days a week, 52 weeks a year.

36:46That's how market making ends up being a very lucrative business, allowing for these market making hedge funds to pay back a certain amount of that money to brokers for the right to fill orders. There's something of an arbitrage going on here. And investors get seemingly free trading, market makers run to repeat across the entire stock market and options market every second. And brokers earn enough to keep the lights on while finding more profitable ways to generate revenue from their user base by upselling with Robinhood gold subscriptions, margin loans, or even just by earning interest spreads on people's cash deposits in the way that a bank does.

37:24And so the conflict of interest that we've already touched on is that brokers may be incentivized to route trades based on who is going to pay the most for those trades rather than the best execution quality, meaning prioritizing getting the absolute best price for customers at all costs. It is pretty isoturic stuff, and I see why it looks bad on paper. But at the same time, I got to say, this model seems way better for everyone than paying $10 per trade, or at least it's better for smaller traders. If you're buying a million dollars worth of stock, which the two of us are not necessarily doing every day, losing a few thousand bucks to payment for order flow scalping is probably very annoying compared with just paying a small, in that terms, normal trading commission like back in the day, which is likely where you don't see too many big rollers on institutions like Robinhood, for example.

38:15And Ken Griffin's hedge fund, Citadel Securities, was made out to be the bad guy in that 2021 GameStop episode. That really put a spotlight on all of this stuff. So I'm just curious, how dependent is Robinhood, even to this day, really on firms like Citadel Security? I think it's pretty safe to say Robinhood relies on just a few key market makers for a pretty significant portion of their transaction-based revenues. Citadel specifically accounted for as much as 34 % of Robinhood's transaction revenues in 2020. And then today, 12 % of their total revenues are tied to transactions with Citadel specifically.

38:57So there is some real concentration in who's paying them for that order flow, even if this transaction-based revenue is only a chunk of the total business. And for context, transaction-based revenues like this, as Robinhood refers to them in their filings, like I said, make up about three-fifths of the overall business. And so three of their top market maker partners account for 25 % of Robinhood's total revenue alone. That's no joke. That's a lot. I didn't even think you would have such a big concentration risk on a stock like Robinhood. So I would say that's a concern long-term. And now we're getting into you know some serious and wonky questions about credit risk as well with what if citadel blows up and then you can't make good on what could be hundreds of millions of dollars that it still owes to urban hood for example so i would say that's a little scary at least to think about without having an extremely nuanced and well-informed opinion on how these market makers actually run but you know without talking too much about that and speculating there just to go back to the bright side one of the things that i was pretty impressed by when i looked it up as you were talking about the IIA match program is that their AUM, so their assets under management of retirement funds has actually ballooned from 500 million in 2023 to over$20 billion in this past summer.

40:21So that's a 40X the amount of money you custody in retirement accounts in just two years. And I think that's very, very impressive. And I'm one of those customers. So now we're getting back to what makes me really excited about Robinhood, which is not the payment forward or flow stuff. Part of what has driven this beyond the attractiveness of the match program in its own right is they also pay something like one to 2 % bonuses on account transfers. So again, that really overcomes a lot of the friction and pains of switching brokerages because there can be some paperwork involved. You have a hundred thousand dollar account.

40:57We're talking about getting thousands of dollars paid to you just for moving your account over. So that's pretty material. And, you know, please don't quote me on any of the exact figures today because their promotions are always changing constantly. And even though it might feel like I'm running some free ads for Robinhood here, I want to say again, they are not a sponsor for our show. And so, you know, all that said, long term, I am not sure how much I care about payment for order flow. It is a substantial part of the business, but it's not what I think will get them to be a compounder that could, you know, double, triple, whatever it is, their market value.

41:33It's all the services they can layer onto that with Robinhood gold, but also outside of that too. I guess you're not alone with that. I mean, just in the last two years, the stock 15x, and that came after many years of actually zero returns in the stock. So all that upside, I think, does not come from the idea that Robinhood makes money from payment for order flow. Investors, in my opinion, expect Robinhood to become probably the biggest finance and investing platform in the world. And that's what they pay for. and what we would have to pay for if we invest in the stock today. One thing that has been really popular is a sort of robo-advisory service, giving people recommended portfolios to use when onboarding their retirement accounts.

42:14Something like two-thirds of customers onboarding retirement accounts on Robinhood use Robinhood's recommended portfolios. And we alluded to it earlier, but they also just keep entering these completely new verticals. So their appetite for growth is just ravenous. For example, they recently launched futures trading, prediction markets, with futures showing pretty significant acceleration. And then in prediction markets, they've already exceeded 1 billion contracts traded in just six months. And so they've even made it possible to do 24-hour trading five days a week, normalizing trading outside of regular market hours, which is once again, flips another part of the financial industry upside down and will almost certainly become a standard feature in the industry eventually.

42:55So that ambitious culture of innovation is very much alive and well. And they continue to soak up market share in these different areas from retirement accounts to prediction markets and futures trading. The other day, they hinted at maybe doing an acquisition of Polymarket. And at the same time, there's so many synergies they can tap into across these offerings, in my opinion, to build a vibrant subscription business in Robinhood Gold, which now has over 3.5 million paid subscribers, which is up 75 % from last year. And including regular users, Robinhood has 25 million customers in the US alone.

43:35So for as much as people like to hate on Robinhood, it is a very significant player in the country's financial system. One of the risks I just can't stop thinking about here, especially when you mention all of their new verticals, is the extreme correlation to financial asset prices. So if the stock market crashes, trading volumes drop, the value of assets in client account falls and people may cancel also their gold subscriptions, you know, and so on. All of that could happen. And I can see how this could compound very quickly against them and kind of undo that flywheel they have been building over time.

44:09Of course, I would say every market sell-off, they are not permanent, but it's still, it makes for a very messy thesis when you have a company whose results can get hijacked so quickly by things well beyond their own control. So then moving into all these different markets from home loans to prediction markets to crypto trading options and everything in between, maybe this is from a perspective of necessity where they're just realizing, hey, we're racing against the clock to diversify their business or our business as much as possible. And when the market soured in 2022, people actually thought Robinhood was dead.

44:43That's what the stock was, what it has been, just because the correlation is just that high. and i think unfortunately for robin hood those things are all pretty closely correlated even if it seems like they're diversifying right they're very closely tied to the financialization of the economy the stock market crashes you're also going to see a decline in options trading and crypto and sports betting and all that kind of stuff and so we'll get into the valuation discussion at the end of the episode but i think that's a pretty good counter argument for why we might want to wait for one of those next air pockets in markets as a buying opportunity for Robinhood, especially as a company is looking to fortify itself against the whims of financial markets more generally and retail investor activity specifically, right?

45:30They don't want to just be completely leveraged to trends on Reddit that drive surges in retail trading. Management likes to claim they have something of a natural business hedge. When rates are higher, they earn more interest on their cash suite programs of customer deposits and then when rates are lower, markets have tended to appreciate and attract higher trading volumes that support these other aspects of their business. They're not wrong. I mean, there's definitely some truth to that, but it's also not an exact science either. I mean, you can certainly have markets declining while interest rates fall too.

46:05So in that case, the natural hedge turns into a double whammy. I still remember when I was at the family office, I think it was in 2022, the markets were completely crazy and so were interest rates. So, you know, while this might make sense or is the case in 90 % of the cases, you could still have the other 10 % happening all the time. And to me, this explains why they acquired a company called Trade PMR back in February 2025 as a way of entering what's called the Registered Investment Advisor, RIA, custody market. So what they're trying to do there is serve a broader range of customer types, including older individuals, higher net worth folks with more comprehensive financial requirements.

46:46And behind that is their big idea, which is what could end up making this, you know, maybe a trillion dollar company one day in the most absolutely astoundingly bullish scenario is where you turn Robinhood into this truly multi-generational platform where you have grandparents, parents, and children all using Robinhood in different ways to build or protect their wealth. They want to make a universal brokerage platform because that's really what has been lacking in the industry, right? You have this generational divide in how people not only invest their money, but custody, what brokerage apps they use.

47:22Older generations rely maybe entirely on third-party financial advisors, or they're using apps like Charles Schwab. While younger generations are pretty clearly open to services like E-Trade or Robinhood or Webull, which tend to be mobile first and digital first and dominate, like I said, this younger cohort of investors. So there is a really big opportunity to be had if you can bring all three generations of investors, the kids, the parents, and the grandparents all under the one roof and having them comfortable with that one platform as being their kind of trusted touchpoint for the entire family.

48:03That is the opportunity. When we were in Montana, you shared some headline stats with me and they were really compelling. I think you said something like the company likes to tell that some$84 trillion in wealth will be passed from baby boomers and the silent generation to millennials and Gen Z over the next two decades. Which is to say that our generation will be coming to a lot of inheritance money that asset managers and brokers will be competing fiercely for. And on that point, you mentioned about the generational divide in money management. There's another crazy stat, which is that 70 % of millennials and Gen Z who inherit significant wealth end up firing their parents' financial advisor.

48:43Vlad Tenev likes to say that himself. So the opportunity is in creating a wealth management platform that appeals to families across generations and leveraging the company's advantages currently with the inheritors of that wealth, making sure they keep it on Robin Hood as they get older. And that's just a pretty significant first mover advantage, if you ask me, in terms of shaping where the youngest generations will store their wealth in the future. But in between now and when a lot of that wealth is passed down, I think there will be a ton of competition for those dollars. You're not going to find much of a counter argument for me because, yeah, you're completely right.

49:19Capitalism is brutal and financial services are very interchangeable. They're fungible and commoditized to an extent. A dollar is a dollar. And that's why I think the Robinhood Gold subscription is so promising because it's a function that converts decent but not wide moat financial products into a complementary ecosystem of much stickier offerings when taken in aggregate. And so, yeah, I do like the long-term plan. Right now, they're focused on gaining majority market share of active traders, which is probably what they're best known for, right? These like day traders, active traders. And by 2027, they think they can be the market leader in options trading and then the market leader in equities trading generally by 2029.

50:04And so we'll see what Schwab and Fidelity have to say about that. That is an ambitious goal. From there, the goals have become number one in wallet share for millennials and Gen Z thanks to Robinhood Gold. And then eventually they've talked about wanting to create autonomous financial agents that can advise you, leveling the playing field with the ultra rich who have accountants and financial planners and assistants at their disposal. And so, you know, that's kind of a wonky idea, but you're already starting to see the inklings of that technology coming to fruition. And so, like I said, the idea would be to give anyone effectively their own family office powered by AI agents that are building budgets for you, monitoring spending, making suggestions about your asset allocation, tax planning, estate planning, insurance and all that sort of stuff.

50:52And so I don't know if Robinhood is ultimately the best one positioned to solve that problem. But whoever solves that, that is a really big market opportunity. You know, it's always so intriguing to listen to all those stories. And I mean, Robinhood is backing it up with numbers. But still, you know, it's a lot of story involved in this stock. And something I like to do with any investment when I consider investing in it is doing a postmortem. So as in, if this totally blows up and fails, in hindsight, what things will we point out as the cannery in the coal mine? What things give the most pause with adding Robinhood to our intrinsic value portfolio?

51:32you. We haven't even talked valuation yet. So that's part of the story here. You've got to get a fair price. And then obviously there's the financial system correlation that we have to think about. Betting on financialization, the continued appreciation of financial assets has been a pretty good bet for a long time, but it's certainly not guaranteed to be over every three to five-year stretch. And I think that's all pretty well understood. I am also trying to wrap my head around the live tentative. On the one hand, he does have this incredibly inspiring story, emigrating to the US, going to Stanford, starting multiple business ventures and becoming the face of this movement to democratize financial markets, which has led some, you know, done some crazy tangents like we saw with the GameStop saga that is just like surreal.

52:16I mean, there's Netflix documentaries on it. And yet, if I'm being totally honest, there's something just like a little off about him. It concerns me just how many public appearances he makes, for example, to talk about Robin Hood's bold visions for the future, which is then to say nothing about the interviews he's done, just about his fitness routine. He did an interview with Men's Health, just talking about how he likes to work out. And so it seems to be that he enjoys being a rock star, which is usually a yellow flag for us because it may mean that they're paying less attention to actually running the business.

52:52And for anybody watching on screen right now, you'll see a picture that lately he has kind of redone himself and he really looks nothing like he did like two or three years ago. And honestly, this is a new look, you know, credit to the PR agency or whoever it was that helped them do this rebranding. But he looks a lot like Pedro Pascal. And it's like not so subtle. He's like very much, I don't know, like trying to mirror Pedro Pascal's image. And so I think you could take that as a compliment. Like, I think he looks good. But again, I worry that it reflects more ego than anything, right? I mean, we want our CEOs to be true operators, people that are just getting their hands dirty, sleeping on the factory floor, flying across the country, making deals, meeting with people, really with their ear to just knowing what everything is going on.

53:43And I'm not going to sit here and say Vlad hasn't been one of those people. I mean, he built this company from scratch. As a mathematician and a founder, he definitely walks the walk pretty well. I mean, he knows everything that's happening at this company. But the question is whether the fame and money have maybe made him want to be a star and whether some of that drive and hunger that made him so prolific early on is fading. So, you know, I'm completely speculating and I'm probably reading way too much into one's appearances, but I just don't think it's been a subtle do-over. It reminds me of the stories I've heard of Lee Iacocca in the 80s as Chrysler's CEO.

54:19He was this charismatic guy who commanded a lot of media attention, but behind the scenes, he'd become increasingly inattentive to managing the actual business. And people were shocked when the business started to fall off, despite the fact that he had been evangelizing it for so long. And people just assumed that they were continuing to do great work. And so going back to the original question, we've learned over time that management matters a lot. I'm not ready to say that I see him as a liability to shareholders in any way at the current moment, because I do really like his vision for the future of Robinhood.

54:53And just generally, I think he's proven himself to be very capable. And we also have a soft spot for founder-led businesses. But if in five or 10 years from now, Robinhood's business does take a plunge and they fail to really manifest these ambitious dreams, I think it would be fairly obvious in hindsight to say, well, yeah, look, I mean, the CEO has been falling in love with himself, spending a lot of time in the public eye, and that is not a good thing for long-term investors. And Tesla has really been the major exception to that for years now, where you have a CEO who is very publicly visible.

55:25But for most CEOs, that sort of pivot toward indulging their own ego does not typically signal good things for shareholders long term. I think it's safe to say that Tesla is very much an exception to the rule. Absolutely, it is. And honestly, after hearing this, I might have been a bit tough on Mark Benioff last week. I actually called him a yellow flag for the investment thesis on Salesforce. And listening to this, Mark Benioff seems pretty normal, I guess. So I don't know. It is definitely important to try and get a read on Vlad because Robinhood is one of those companies which actually has a dual share class protecting the founder.

56:04So basically making Vlad's shares have many more voting rights than everyone else's so that he effectively controls the company as the most powerful shareholder and CEO. I actually did come across a clip of Vlad that I thought was really compelling, making the case for Robinhood's biggest moat, if we want to listen to that now. I think the biggest moat is just the product velocity and the innovation that lies downstream of that. I think we're fortunate that, you know, we're not competing directly for assets against the most sophisticated incumbents, right? It's not like OpenAI, XAI, and Anthropic are.

57:16our closest competitors. It reminds me of Nubank and how they made it look so easy to build digital first products that their legacy bank competitors don't have the software talent or organizational nimbleness to build themselves. The one thing that I keep thinking about is what kind of data the team at Robinhood must have seen for them to realize that they could go from being the place that people think of for meme coins and Reddit stock trading to actually being a credible and trusted financial institution for millions of people beyond just day trading. I mean, that was a big pivot for them.

57:53When gold first came out back in the day, it was premised around providing benefits for active traders, where, like I said, now it's a much more broadly appealing offering so that people like you join the app again, right? So what did they see that not only led them to change the direction of Robinhood gold, but to double down on it in such a big way? Well, I'm certainly not a day trader. So yeah, this is how we like to use our insights as customers to inform our, not that we invest in every company that we love as customers, but sort of just to provide us signals about possible ideas that may be interesting.

58:33I think Peter Lynch would very much relate to that or approve of that, given his book, One Up on Wall Street, where he talks a lot about just keeping your eyes open to the great businesses you encounter every day. so yeah I'm one of those people that reflects maybe the new tide change at Robinhood in this new direction for them and so I could say pretty confidently that gold subscribers are significantly more valuable to Robinhood than the typical free user especially the type of gold subscribers they've attracted in the last few years since they've really rebranded it just to give you some stats gold subscribers have approximately five times more assets under custody on Robinhood so They're willing to bring much, much more money onto Robinhood's platform with a 1.2 to 1.4 times faster net deposit growth rate, and then a four times higher retirement account adoption rate compared to the average customer.

59:27And so the insight was not that people willing to pay a subscription fee are wealthier and therefore better customers, but it was that as people get more entrenched in the Robinhood ecosystem, like I found myself doing, the more they trust the platform for these other services. And it's not necessarily obvious that having a credit card with Robinhood, for example, would make it significantly more likely for you to also create a retirement account with them and deposit more cash in your brokerage account. But that is exactly the sort of data I think they've seen that has underpinned these decisions.

59:58To me, it sounds a lot like Uber with the Uber One membership. They're offering 6 % back on rights and free delivery on Eats plus some other perks for a few bucks in monthly subscription fees, basically. And people end up using Uber much more frequently for both ride-hailing and food delivery over time, all while creating a pretty steady subscription revenue stream for Uber. And if a company didn't have a suite of generally valuable products and services that could be bundled in this way, I think the offerings wouldn't work out. But Uber Eats and Robinhood's credit card and IRA match are generally great standalone products, and they work even better in tandem when there's something like a rewards program for using them more.

1:00:39And I think that's what these subscriptions are all about. And obviously, Amazon figured that out a long time ago before any of these companies even got that idea. Ultimately, Robinhood aims for gold adoption to be so obvious for every customer that, yeah, it's undeniable. And it's definitely become increasingly obvious to folks. Newly funded customers adopt gold at a pretty high rate and that rate is rising, which is really compelling to me. In Q424, it was over 30 % of customers that were converting to gold. And now over 35 % of new users with funded accounts ended up signing up for gold. And to me, that is very, very promising.

1:01:18And from a unit economics perspective, the payback period for offering something like a 1 % match in all IRA contributions is about a little under one year. While for the 3 % match, it's between two and three years. But there is a positive payback period. And Robinhood monitors these cohorts closely and has observed that the 2023 cohorts have already paid off for them, with 2024 cohorts showing that they're off to kind of a similarly strong start, with the point being it takes a little time for these expenses to pay off. They are sort of like marketing expenses. But if it turns someone into a customer for the next decade, the next two decades, someone who brings their entire family onto the platform and who increasingly uses more of Robinhood services as their wealth combines, I mean, obviously that just can end up working out very, very well.

1:02:06And whatever costs they lost up front by giving somebody a generous contribution program end up more than paying for themselves. And so the company calls it a gold flywheel where improvements to individual product pieces benefit the entire Robinhood ecosystem. It's very sticky like Amazon Prime is, as we've mentioned more than a few times today. If you've got your high yield savings account, your individual retirement account, your joint brokerage account with your spouse, your credit card, and even a home loan through Robinhood, how likely at that point are you to cancel your gold subscription, forfeit a lot of those benefits, and then switch to another brokerage?

1:02:40That may not be nearly as asset light in digital first and able to offer the same sort of appealing benefits back into customers just because they have a different cost structure. No one else has been able to do that all in one offering to the same extent. And if they did, I think it would take significant promotions to draw you over, right? You would have to offer something even more compelling than what Robinhood is able to offer. So, you know, adding to the sickness of gold is, like I said, that you forfeit those really great benefits if you unsubscribe. I'm actually surprised by how quickly it's profitable for them to go with all of these different products and all of these different offerings.

1:03:18But as you said, I mean, maybe you want to get away from Robinhood at some point for some reason. But are you really going to if it means losing maybe the best credit card you have that gives 3 % back on all transactions and losing 3 % match contributions to your IRA? And again, I'm not even the type of guy who looks for those offers, but these seem so much better than all else that I would doubt people would actually leave. And I haven't seen any other broker offer an IIMH at all. So I would probably pay a lot more than just$5 a month for that on top of getting what is just objectively a very good credit card.

1:03:51Cards that offer 2 % back on everything are typically considered pretty good. And Robin Hood's card is a notch above that. Robin is actually likely losing money on every single transaction on that credit card because they're giving away more in cash back than they get from the sharing of transaction fees. I know you understand payments better than me, Daniel. So you can tell me if that sounds about right. But I do think it's a sunk cost, again, that they're taking on intentionally because credit cards are such sticky products, right? They're not making money necessarily on the credit card, but it's the gold subscription.

1:04:25It's the likelihood to bring more retirement assets onto your account to deposit more cash in your brokerage account, maybe to take on more margin loans. There's all sorts of other ways that they can make money from that relationship without specifically having the credit card be super profitable. And so the prime comparison works well, but you can also compare it to Costco. I know that when we were in Montana together a while back, Daniel, it was your first experience in a Costco. It was actually only like my third time going, which maybe people are surprised to hear. But one of the things that really stood out to us and that they're famous for is obviously Costco sells a bunch of products effectively at cost, but really what they're famous for is$1.50 hot dog and drink combo that they sell that is obviously not profitable, but yet it's just kind of a sign of their commitment to returning value to customers.

1:05:17And they hope that that kind of thing will be able to keep you as a recurring customer who continues to pay for a membership. So they're losing money on the products they give away or for a lot of products that are break even, but they make it all back and more with subscriptions. And I think you could say Robinhood is doing the exact same thing, maybe not at the current pricing of Robinhood Gold. There's no reason why over time they couldn't raise the cost of it, especially as people feel increasingly locked into it. We've seen Amazon Prime do the same thing. And a credit card with really good benefits is effectively, like I said, a marketing program that works to not only draw new users to their platform, but just makes them more reliant on the Robinhood ecosystem.

1:05:56And the potential here is for Robinhood to ride the wave of our generation's wealth accumulation. Right now, the average customer account size has doubled in just two years, but it's still less than$10 ,000 per account. Whereas a broker like IKBR, Interactive Brokers, I mean, their average account balance is an order of magnitude bigger, right? It's on the order of$170 ,000 approximately. So they're catering to dramatically different types of customers. And so Robinhood, to use another analogy, is sort of like a Trojan horse to these established financial players who think that they're seeding the investors on the lowest end of the spectrum, who are barely worth competing over today because they're young people that don't have huge net worth.

1:06:43but these are the folks who will be controlling society's wealth as the older generations age out. And so actually it's a very long-term play on building their earnings power around a generation that is very well positioned. Whereas if you're only catering toward the older generation and you have no appeal with the youth, once that generation ages out, you lose a huge chunk of your customer base. And that's why I think Robinhood has a really unique position of strength working in their favor. I mean, in theory, that logic is not too difficult to understand. So to naively ask once again, why don't these other players don't just copy the same promotions that Robinhood does?

1:07:23I mean, Amazon's logistics, mastery and their scale, they're just really hard to match, which is why you can't just clone Prime. But it seems like it would be way easier to do that in financial services. I think it's easier said than done, but somebody really needs to go through every episode we've done and figure out the number of times we've invoked the innovator's dilemma because it feels like for almost every episode, we somehow talk about the innovator's dilemma. But yeah, it really is the innovator's dilemma for these established players. They're doing what has always worked for them. And it's hard to really dramatically change that before the business has started to fall off.

1:07:57So if catering to younger demographics the way Robinhood does comes at the expense of your boomer clients that are massively profitable currently, while driving away super profitable customers in favor of less profitable ones that will maybe be more lucrative down the road is not going to be something that's super popular amongst shareholders of the stock and the board. And if you're a manager getting paid on quarterly or annual incentives, it's just really hard to fight that inertia and do something that is maybe in the best interest of the company over the next 20 years versus what's in the best interest of them meeting Wall Street's targets next quarter.

1:08:36So these legacy players are coming to the competition with Robinhood with a lot more strings attached. It's very similar to the conversation we've had with NewBank. But I do think also maybe a more nuanced explanation from management that I've heard too is that their competition is effectively trapped by these entrenched, low-yielding asset bases. Okay, so I guess I will use our audience here. as an excuse to ask you to explain what exactly that means. Yeah, so large incumbent brokers and banks like Schwab or Bank of America are still sitting on huge portfolios of bonds that were bought when interest rates were near zero in 2020 and 2021.

1:09:19And those portfolios often live in held to maturity buckets, as they're known, where they keep paying low yields for years. And for anybody who followed the regional banking crisis in 2023. Even Buffett talked about this in the shareholder meeting. A lot of this will sound familiar. And because they're so big and slow to turn over, which is why I call them entrenched, the average yield of the whole balance sheet at these firms stays low, even if today's short-term rates are 4 % or 5%. And yet, anyone who's a little bit familiar with bond math, selling those bonds to reinvest into higher yielding bonds would then lock in the big paper losses they have on these bonds that they basically paid a higher price for, which is why the yield is lower.

1:10:04So essentially, you know, that is why they mostly just wait it out. And that makes it tricky, honestly, to be as aggressive as Robinhood is with some of these promotions, like the account transfer bonuses they do. Because a transfer match where you pay someone a cash bonus equivalent to 1 % of assets, they move over. I mean, that is a major marketing expense to be able to front at the beginning of that client relationship. And so to justify it, the broker needs to earn it back from the customer's future economics, primarily net interest income on cash and margin, and then any trading and subscription revenues as we've talked about within those payback periods.

1:10:38And if your asset base of your balance sheet, the yields are so low and your net interest margin is already very thin, then the payback takes longer comparatively. It's just an example. If an incumbent competitor has a blended net interest margin of, let's say, about 2%, weighed down by a bunch of these COVID-era treasury bonds, then paying a 1 % match up front requires approximately six months of that spread for them just to break even before other servicing costs, churn, or cannibalization from raising customer cash yields. So the takeaway is that is a tough ROI bar at scale to overcome. And the other thing is Robinhood is betting on their customers, as we've said, becoming much wealthier in the future.

1:11:23So if they pay them 1 % on the$10 ,000 they move over, and then that person inherits$500 ,000 in 10 years from now, boy, that ends up being a much better and very different investment in their customers than it would be for Schwab to pay out 1 % matches to its already high net worth users that might be bringing over millions of dollars, which 1 % of a bigger number is a bigger cost. while their account balances actually dwindle over time, right? As you have retirees spending down their asset base to fund their retirement. So if you really kind of pull back the onion, the economics of what they're doing are just totally different because of really, I do think Robinhood kind of has an advantage by being a younger company that's not held back by their customer base or their asset base.

1:12:15So everything from their balance sheet to customer profile, can shape whether these promotions make sense. And I was as skeptical as you of like, how can they be making any money? How do these generous bonuses and transfer stuff, how does any of that make sense? And for Robinhood's competitors, I would say they don't make sense in the same way. And that's why I use that Trojan horse metaphor for Robinhood. They believe the lifetime value of the assets they're acquiring dramatically outweigh the upfront hit. And intuitively, that makes sense to me without, you know, really being able to fully audit the unit economics of all the customers they're bringing over.

1:12:55And I just think it's an equation that is harder for the incumbents to make work. That's a very compelling argument. And again, a lot of it is reminding me of Nubank. And maybe to a certain extent, it's an even stronger mode by being a new company than Nubank, or at least a stronger advantage that Robinhood has as being the younger company than NewBank had. And last week though, we talked about another high quality company. We were close to investing in it, talking about Salesforce, but there was some yellow flags that made me pause. And I said before, one of them, at least back then I considered to be the CEO, but another one was the substantial stock-based compensation that they had.

1:13:32And I think it was around 8 % revenue and about 25 % of free cashflow. And when I look at Robinhood's stock-based comp, it's pretty substantial as well. It's even a bit higher. So despite all the excitement, I had to at least bring it up. What are you thinking about that? I appreciate you doing so because it is a real expense. Like many Silicon Valley companies, they've historically played a bit fast and loose with stock-based comp. As a percentage of revenue, it has come down in the last few years. But we're still talking about 8 % of revenue going towards share dilution. Historically, before its IPO, Robinhood did not record stock-based comp expenses on the restricted stock units, RSUs, that they had issued because they were contingent on the company going public.

1:14:12But upon its IPO in 2021, the company recognized a massive one-time cumulative charge of$1 billion in stock-based compensation for those RSUs and then began recognizing RSU stock compensation going forward. I felt like a word salad, but basically the IPO year was an outlier that brought forward a really hefty amount of expenses that you could argue they weren't accounting for fully as a private company. But now a lot of that is behind us, right? Those effects have already basically come to fruition. And so the share count has steadily trickled up by about 1 % a year post IPO, which is a substantial headwind to returns going forward.

1:14:56And actually, you can see on screen that there was this random decrease in the share count in 2023. And it's maybe a story for another day. But that's from them spending$600 million to buy back Sam Bankman-Fried's stake in Robinhood through FTX. I'm sure a lot of listeners will remember that saga or recognize the name. But besides that, their ongoing buyback program is really not big enough to offset the impact of dilution, unfortunately. And if I were to give them the benefit of the doubt, they would probably say they can generate better long-term returns by allocating that cash toward marketing programs like they've done.

1:15:31And that is probably even true. But I do hope they consider more significant buybacks or doing less stock-based compensation to the extent that they can as the business matures, just because that dilution is just so painful to endure. And maybe to talk a bit more about stock-based comp, because we prioritize it a lot when we talk about it. I mean, people often think that if you're reducing shareholders equity by the amount of SBC and increasing the share count by the amount of shares issued from SBC, that's effectively double counting the impact of the SBC. But that's actually not the case. Every expense has an operating component and a financing component.

1:16:07And if you compensate your employees in cash, you expend that cash cost on the income statement as an operating expense and you reduce cash on the balance sheet as a financing cost. Now if you pay your employees with stock, you recognize the cost on the income statement and increase paid in capital on the balance sheet, which is offset by the lower returned earnings from expensing it. In other words, stock-based compensation is an expense and it increases the share count. So EPS excluding stock-based comp is just not an appropriate measure of economic earnings. It's non-cash in the same way that depreciation is non-cash.

1:16:43It is added back to free cash flow, but it still is an expense. And one way to think about why Sean and I fixate so much on this is that an increase in share count impacts EPS in perpetuity. So the cost is just much higher than what it seems when just considering the year-over-year increase in share count. I mean, 1 % increase in share count each year just doesn't sound like a lot. But okay, since I've now rambled on about stock-based comp, Maybe you can tell us a bit about how tokenized equities work, because that's a huge other thing that Robinhood is now currently going into. There's just so much to talk about with Robinhood.

1:17:19I feel like we'll get to the end of the episode and there'll still be a bunch of areas that we've not had adequate time to touch on. But yeah, I mean, Vlad Tenev has compared stock tokens as being like the stable coins of the equity world. and they actually think just about anything can be tokenized on the blockchain from real estate to private equity. You know, this feels very 2021-esque, but I do think there's some legitimacy behind the ideas here, even if they've been swept away with some exuberance in the past. And basically what they're doing and why you could do this with real estate and private equity and all these other things is just because they're pulling together some asset and then minting or burning tokens against it to keep the token value steady as a claim on that pool.

1:18:06So, you know, actually, that's not so different from how an ETF works. And really, the way you could imagine this is Robinhood could buy a thousand shares of Tesla stock and then issue 1000 Tesla stock tokens tracked on a blockchain that are redeemable for one share and then create a market for trading those tokens that can be traded anytime. And it's just how you get to this sort of, you know, stock exchange is closed. And it's actually bypassing some of the frictions of the traditional financial system. So the idea is actually pretty interesting. I'm not going to wholesale endorse it, but it's really interesting.

1:18:44It's creative. And so actually more interesting to me, and we saw Robinhood do this last summer in Europe, and that is they created tokenized versions of private companies' shares. So due to accreditation laws, individual investors can't invest in companies like OpenAI in the US and they don't meet a certain wealth threshold. But if Robinhood buys up a stake in OpenAI and then breaks it into fractionalized shares with corresponding stock tokens, then in theory, anyone could buy those tokens on the blockchain and have exposure to investing in what is the leader in LLM and AI technology. And I'm still skeptical about all this.

1:19:23And it's not really even legal in the US currently, but I can at least appreciate that as they like to claim. This is objectively a way of leveling the playing field with the wealthy, giving anyone the chance to invest in private companies. People have their opinions on whether that's a good thing or not. We can disagree about it, but they are sticking true to who they say they are, right? Taking things that were not available to the general public and just giving people more investing options. And so, you know, otherwise, retail investors would effectively be boxed out of investing in the companies that could be the next mag seven.

1:19:55And I think the issue has gotten worse over the years as more companies tend to stay private for longer. There's a lot of data showing that the number of publicly traded companies down by half since the mid 1990s. So there are just fewer investment options structurally available to the masses these days. And the thing is, each token confers economic exposure that is meant to be equivalent to one share, but is not full legal ownership of the company, which is where things get weird. The SPV, the special purpose vehicle that Robinhood holds these assets in is the actual shareholder of records. So as a result, token holders, right?

1:20:34If you get some open AI tokens, you lack any kind of meaningful voting rights. The SPV, the special purpose vehicle that Robinhood has set up to hold the bundle of assets here will essentially exercise any shareholder votes or more likely just abstain. But still, you're basically, you're forsaking some voting rights. But I would say that generally, this is an interesting way for folks to around the world gain access to US stocks and privately listed companies, as I mentioned. You know, what I think is an easier way is, and that's some self-advertising here, is to join the intrinsic value community.

1:21:14And as we already talked on another podcast, we already had the opportunity to invest in OpenAI, which was a pretty funny thing. And we didn't end up doing it, but I thought I would plug it in here at some point. I mean, honestly, when I listened to all of this in some way, and I might misunderstand this completely, this reminds me of the VAE structure of US-listed Chinese companies. You have an economic interest, but you have no voting rights. And at least that's how it sounds to me. You also have no legal control of the share that you're supposed to usually own. And I think OpenAI's reaction also showed that the private companies themselves don't really like that idea.

1:21:49I mean, they made it very clear that they do not endorse the approach at all. And I guess Robinhood wouldn't be where they are today if it hadn't occasionally tested the boundaries of what's legal. And just speaking about those boundaries, how about the prediction markets? I think that's another big topic. They're being touted as the next big thing in the US. But honestly, to me, they still look a lot just like gambling. Yeah, this is another gray area that some people will say, yeah, I know what a prediction market is. And other people probably listen to this like, what are they talking about?

1:22:20But it was a really prediction markets are technically futures contracts, according to the CFTC, which is the regulatory body that oversees futures trading. So in the eyes of regulators, at least it's not gambling. It's a futures contract. and Robinhood is powered by a company called Kalshi, which is sort of the big name in this space besides Polymarket. And so there is in theory real value in being able to put on a hedging position related to things like the Fed's rates or inflation, for example. If you make a futures bet that pays off because inflation is unexpectedly high, in theory that could help real people hedge the costs of groceries going up or that's how the CEOs of these companies would want you to believe it is.

1:23:06And so, you know, in reality, I feel like this stuff overwhelmingly gets used for things that look very close to gambling. And sort of how like a lot of people go on Robinhood for the meme stocks and not actually for the IRA match like me. You know, so you have these different things and the way people use them can vary widely. But yeah, I do remember for the Super Bowl this year, Robinhood couldn't actually let you bet on the Chiefs or Eagles by name for some reason, but they could create a futures contract where you could bet on the quote-unquote team from Kansas City or the team from Philadelphia.

1:23:40So yeah, they've come up with some creative ways to technically bypass some sports betting laws. And you can either see that as a culture of innovation or some people see that as this, you know, fraudulent company that is actually trying to, you know, capitalize on our worst instincts. And I'm not sure that either characterization is completely accurate or inaccurate. But from a business perspective, gosh, the number of potential prediction market contracts that you can have is really just mind-blowing. It's only limited by your imagination from how many rate cuts will there be this year or next year, how high will egg prices rise, who will win the election, what will the jobs numbers be this month, what will unemployment look like?

1:24:22I mean, there's just so many from climate change to economics to sports and culture and politics. There is a lot of different prediction markets on these platforms like Kaushy that folks can make bets on. And we're seeing more of that trickle into Robinhood. And so it also opens the door for them to steal market share from companies like DraftKings, which are already multi-billion dollar companies trading publicly at this point. And so still, I worry that sports betting and stuff like that only adds to some of the negative stigmas surrounding Robinhood that could hurt its perception as a serious all-in-one financial app, right?

1:25:01I'm much more interested in this bigger vision where our generation inherits wealth and keeps it on the Robinhood platform. And anything that potentially distracts from that kind of scares me. But still, Robinhood is almost very libertarian in a way. And this aligns with their ethos. They want to make everything available to everyone. And maybe there's something democratic about that, but there are some real societal costs that we can debate about it too. And so I don't think as a culture, we're better off now that sports betting is easier than ever. But that's just my personal opinion. It's just, you know, to me, it's not a good look to have sports betting in the same app and keep my retirement account.

1:25:36But different reasonable minds can differ, as I've said already. Absolutely. And I think for the people maybe wondering why we talk so much about ethics, I think it's just pretty important for the business. If you think about, you know, getting millions of dollars onto your Robin Hood account eventually, and at the same time you know there's an app that you can gamble all sorts of things. I think there's a reason for why it has been or the entire business has been so split up with you know the Charles Schwab's who have these high net worth individuals and then Robinhood and then gambling sites and putting all into one might sound if you just look at the business aspect like a perfect idea but if it actually works out or if it's just hurting the business or at least a bigger thesis that's something you need to discuss in a podcast like this which is supposed to be a deep dive.

1:26:23But anyway, we have been down a lot of different rabbit holes today. So the last one, and I promise it's the last one I will take us down before we get into the variation is Robinhood's subsidiary business. So my understanding is that they vertically integrated their brokerage business, bringing much of the, basically the behind the scenes work that sometimes gets outsourced to third parties in-house. Yeah. So Robinhood has two wholly own subsidiaries and Robinhood Financial and Robinhood Securities. And as you said, these subsidiaries support the company's ability to do its own brokerage and custody of financial assets and transaction clearing in-house.

1:27:01And so when you place a trade, Robinhood Financial is the company you deal with in the app. It records your order, handles your interface, et cetera. But once a trade is executed, Robinhood Securities is the one that ensures that it quote unquote clears, meaning the proper exchange of cash and securities is completed by the correct deadline behind the scenes, right? You know, obviously you buy shares in your brokerage app and all of a sudden it says, yeah, you just have 10 more shares of Apple. But there's actually, you know, some legal complexity behind the scenes to actually ensure that you properly own those shares.

1:27:35And so in case of issues with settlement, where you have these failures or delays in transferring ownership or transferring cash, those would largely reside in the Robinhood securities subsidiary, leaving Robinhood financial shielded to an extent from some of those back-end risks. But obviously, the firm as a whole is responsible for oversight and disclosure. And that vertical integration ultimately helps the company capture more interest and lending income while reducing third-party fees. But it also requires substantial regulatory capital because it exposes the firm to the fluctuations of clearing fund deposit spikes and compliance risk.

1:28:11And to put that differently, by replacing a third party clear, Robinhood avoids external per trade and processing fees and captures activities that would otherwise be shared, like the interest it earns on segregated cash and deposits at clearing organizations, as well as a stock lending spread. And so that might sound like gibberish to a lot of folks, and that's okay. I think the simplest way to say this is that Robinhood has opted to take on more financial and regulatory risk to try and make its business more efficient and profitable, for kind of a lack of a better way to say it. And that's not necessarily inherently good or bad.

1:28:46It's just complicated. And when they began this move in 2018, management described it as a way to lower fees and run a faster, more reliable tech stack on modern technology. But yeah, direct control over transaction clearing and custody does support features like fractional shares that we've talked about since the company has its own ability to have an internal inventory of shares. And yet at its own clearer, Robinhood Securities is directly responsible for ensuring all trades settle correctly with clearing houses like the DTCC, which stands for the Depository Trust and Clearing Corporation. And so if a customer defaults or trades create big imbalances like we saw during the meme stock frenzy of 2021, Robinhood itself must provide collateral to that clearinghouse.

1:29:35And this is why in January 2021, Robinhood notoriously had to post billions in margin with the DTCC, which led to trading restrictions that created all these conspiracy theories that Robinhood was colluding with hedge funds to suppress buy orders on GameStop, which, I think we see that as being nonsensical, obviously. But this really did damage their reputation with customers for a period of time. And so when you have the DTCC demanding$3 billion in collateral from Robinhood Securities, it's the Robinhood parent company that we'd be investing in that has to raise that emergency capital, which they did in just a few days from investors by raising equity in the company.

1:30:16They raised$3.4 billion to essentially backstop those clearing obligations, but you don't typically want to see a company diluting shareholders with equity sales because they didn't properly manage their regulatory risk exposures. That was a pretty big red flag for the company. So even though the clearing operations and parent company are segmented as separate legal entities, shareholders in the parent company, as we would be if we bought Robinhood ticker H-O-O-D on our brokerage app, they're ultimately on the hook because Robinhood is the one that has to step in to keep the clearing business solvent and compliant.

1:30:56Otherwise, the entire company falls apart. I usually say that I don't care too much whether a business is cyclical as long as I know it will survive a downturn. Because if that's the case, chances are it will actually be stronger afterwards because weaker competitors just did not survive. In Robinhood's case, though, it's important to keep the cyclicality in mind because the company is laying on a lot of complexity with clearing custody, crypto, credit cards and retirement accounts. And that vertical integration works great in stable markets. But if the economy were to turn, I guess all those moving parts could create some serious problems as well.

1:31:32I mean, the 2021 collateral that you just told us about was already a glimpse of how quickly that can escalate. And I guess we could talk another hour about all this stuff that is happening at the company, but since we're already running for now it's over almost a hundred minutes, how about we get into the valuation now? So I'm going to have to punt here a little bit. This is a tricky company to value in a traditional sense because numbers like free cash flow, for example, are going to be greatly distorted by customers trading activities since Robinhood is ultimately a brokerage company. If there are spikes or drops in trading activity that can ripple through their financial statements, showing these swings in cash inflows or outflows that are temporary.

1:32:13but may not have yet canceled out at the exact moment the financials are being reported. And so the adjustments you'd need to make to normalize the company's earnings can be really, really messy. And honestly, they're beyond my range of expertise. Banks are sort of already on the edge of my comfort zone and valuation, but I just find brokerages to be even more confusing. And that may just be because this is really the first brokerage company I've ever really looked debt to try to end value. And so anyways, we can't just blindly use free cash flow with a financial institution like this. And gap net income is going to be better, but there are still flaws with that number too.

1:32:53So I mean, there's just so many variables you have to implicitly account for with a company like this. And when you project earnings growth, you're implicitly making bets on not only how much trading activity there'll be in crypto and stocks and options, but you're also doing things like you would want to model the growth in their subscription ecosystem like Robinhood Gold. And so Robinhood is just fundamentally a cyclical company in that they're closely tied to the amount of trading and wealth in aggregate and financial markets. And while they're trying to change that with their subscription business and Robinhood Gold, you just can't entirely diversify out of that cyclicality as a brokerage business that's also involved with banking and credit cards.

1:33:32It's just not possible. And so the point being to actually model Robinhood's earnings, you'd want to account for maybe different sensitivity analysis of how their net interest income would be impacted by different levels of interest rates. And that's actually something they report in their 10K of, I think they said, if interest rates went down 200 basis points, that would cost them hundreds of millions of dollars in net interest income. And then if you're betting on more stock trading based transaction revenues, this is not some linear thing either. Like I said, financial market activity can swing dramatically with peaks and troughs and euphoria.

1:34:04And so stock trading volumes could double or get cut in half. And there's just no way of knowing with any confidence what will actually happen on a several year time span. And long term, yes, I'm pretty sure Robinhood will have more customers and more accounts lead to more transaction based revenues if you zoom out long enough. But guessing what will happen in the next five years is really totally random. And it requires a lot of patience to invest in something where you just have very little faith in whether the business could just nosedive in six months from now without really any kind of obvious indications to you of why or how that would happen.

1:34:43And so if you contrast that with our intrinsic value portfolio company, Adobe, where something like 90 % of revenues or actually I think more come from recurring corporate subscriptions, God, that is a really sticky business model. With a company that's been an industry standard for three decades for creatives and marketing agencies, estimating roughly what may happen to their business over the next five years requires much less speculation than modeling Robinhood's business. And I put together an extremely basic model, even more basic than we normally do to get a totally subjective, flawed baseline idea of approximately what the fair value may be.

1:35:21And so I'll be the first to say I kind of rushed through this. I'm not putting a ton of conviction in the specific number. Other than that, really just my model tells me intuitively, even with pretty optimistic assumptions about continued growth and margin improvement, it's clearly overvalued and maybe very significantly. So after, like you said, it's been like a 15 bagger in the last two years. And so as always, I'll kind of cop out and just say you can see more about the models we build and this one and our free weekly intrinsic value newsletter that, yeah, is free to sign up for. And we put it out and it basically complements the podcast.

1:35:58It's kind of a condensed version of the thesis with more focus on some of the numbers and modeling. And so I didn't make as comprehensive of a model as I could have with all these different sensitivity analyses of interest rates and trading volumes and growth in gold and their pricing power and so on, probably just due to laziness. But also because without even getting that deep into the valuation, it's just obvious to me that, you know, this is not super attractive. So why spend a bunch of time modeling if you know the company is probably overvalued? And so, I mean, this is something that's trading at 30 times sales, for goodness sake.

1:36:29But back in 2023, the stock market had turned down and speculation and crypto trading fell off. So Robinhood's business suddenly looked much worse. And yet the business was still profitable in unrolling these early glimpses of the gold program that I think we now see as being very promising. And so the market didn't really care about any of that, though, at the time. and the shares just got clobbered and were trading at tangible book value, actually just a bit below it at times. So in a moment like that, when these temporary external factors had killed sentiment while the company was setting the foundation for a very compelling subscription program, in hindsight, we weren't doing the show at that time.

1:37:05But that is when I wish we had looked into the company more seriously. And so this is actually exactly what Derek Balecki of Gator Capital Management saw at the time too. And he had the good instinct to jump on the opportunity back then. And it's safe to say he's done very well. The stock has more than tripled since when he first invested in it. And our colleague, Clay Fink, actually interviewed Derek about that experience previously. So we'll provide a link in the show notes for anyone curious to learn more about what it really meant to spot the Robinhood opportunity at the time when the asymmetry was really most in favor of long-term investors.

1:37:40You know, in hindsight, it's always easy, but I'm sure it's still somewhat frustrating to you because you used to use Robinhood, you said in college. So maybe there's some part of you that at least feels like you should have picked up on those clues on the ecosystem they are building. But otherwise, it sounds like at$100 billion plus market cap, the variation is probably just very rich and speculative at this point. I've made that mistake a few times, which is why I say I really want to follow my customer insights more because I used Reddit for years. I participated in the IPO at whatever, 30,$40 a share, whatever it was.

1:38:16And then I immediately sold when it popped. And then I found myself getting back into the stock at like 90 or a hundred dollars a share. And at the time of recording, we're well north of, of$200 a share. So this is not the first time that I've talked myself out of or overlooked a company that I knew as a customer, I really enjoyed the value proposition. So we always save the valuation for the end of the research process. And sometimes that does result in falling in love with a business that the market actually loves even more than you do and not realizing that until you've already sunk many dozens of hours into the research process.

1:38:52I think you could say that is a little bit of what happened here with me. And so I got excited about Robinhood maybe being the Amazon Prime of financial services. And I'm sure my model is way too conservative of accounting for their earnings power, but still well, I'm getting a fair value that's a fraction of the current price. So really, I think we've done the initial legwork here. And this is a name we should consider revisiting if we get a major contraction of the stock. So if we get 40 or 50 % drawdown over the next 18 months, then I would definitely put more hours into doing the necessary modeling to feel more confident about the right entry price specifically.

1:39:27But gosh, we're just so far from that right now. It doesn't really feel worth bothering with. And so I'm really pitching this idea generally to help me better understand the qualitative thesis by talking it through with you in terms of how realistic is it to believe that they can be the Amazon prime of Gen Z's financial services. But beyond that, at almost 14 times price to book, I don't think rigorously trying to estimate an intrinsic value for this company at the present moment is going to be the best use of our time, honestly. I'd have to be much more bullish than I am to underwrite assumptions that would justify the current price, which is not to say I want to short Robinhood or bet against them by any means, but I just don't have a strong enough opinion to say that it's undervalued at current prices.

1:40:06And so the great thing about investing is that we don't have to swing at every pitch. And I would say we wait on swinging on this one for a little bit longer. Absolutely. I guess we have actually been too late for this one. I mean, that doesn't mean that we cannot get a second shot at, you know, buying it. As you just mentioned, we have the cyclicality. The stock has traded at totally different valuations just two years ago. So there might be another shot, but as exciting as the story about the company is the market has it priced for becoming an all-in-one finance platform already so by buying it now i think we wouldn't be much better than you know people on robin hood that gamble on the next super bowl final ideally we would want to find companies where the range of outcomes is just heavily screwed to the upside where we don't have to pay much for that potential with robin hood the range of outcomes is still pretty wide in both directions.

1:40:56And at these prices, I would say you just have a lot of risk going to the downside. And that said, as you just mentioned as well, the company's overall trajectory just looks incredibly promising. And I would definitely not want to be the guy that bets against the company. Shall we move on to some hints for the pitch you'll be making in next week's episode? We should do that. We should do that. And well, next week, you will hear about a company that definitely already has a white mode and a very profitable business in an industry that I think we haven't yet covered on the show at all. It is a serial acquirer, but it's not constellation software.

1:41:30And it's operating in a space where I would say you could argue that it has very strong tailwinds. And I think it will make for a pretty compelling pitch. And I also think we have a couple of experts on that sector in the intrinsic value community. So I'm hoping they can help me get up to speed a bit faster than I could on my own. And actually, when I wrote up these hints, I thought, okay, no one could guess this. But then I asked ChairGPT to give me his three stock ideas up on those hints. And he actually gets a company. So I think it's enough if you really are getting into the hints to find out what company we're covering next.

1:42:03Okay. All right, folks. Because I'm feeling a bit inspired to change the world after seeing what Robinhood has been able to do. Let me close this out with a quote from none other than Steve Jobs. He says, being the richest man in the cemetery doesn't matter to me. going to bed at night saying we've done something wonderful. That's what matters to me. We'll see you all back here next week.