Falling -3.7% today, shares of Robinhood Markets are giving us reason to question their average rating of buy. Did analysts get things wrong about this stock? Let's dive into the numbers to see whether HOOD is overvalued at today's price of $94.4 per share.
The first step in determining whether a stock is overvalued is to check its price to book (P/B) ratio. This is perhaps the most basic measure of a company's valuation, which is its market value divided by its book value. Book value refers to the sum of all of the company's assets minus its liabilities -- you can also think of it as the company's equity value.
Traditionally, value investors would look for companies with a ratio of less than 1 (meaning that the market value was smaller than the company's book value), but such opportunities are very rare these days. So we tend to look for company's whose valuations are less than their sector and market average. The P/B ratio for Robinhood Markets is 10.5, compared to its sector average of 1.78 and the S&P 500's average P/B of 4.74.
Modernly, the most common metric for valuing a company is its Price to Earnings (P/E) ratio. It's simply today's stock price of 94.4 divided by either its trailing or forward earnings, which for Robinhood Markets are $1.75 and $0.73 respectively. Based on these values, the company's trailing P/E ratio is 53.9 and its forward P/E ratio is 129.3. By way of comparison, the average P/E ratio of the Finance sector is 15.92 and the average P/E ratio of the S&P 500 is 29.3.
If a company is overvalued in terms of its earnings, we also need to check if it has the ability to meet its financial obligations. One way to check this is via the so called Quick Ratio or Acid Test, which is the sum of its current assets, inventory, and prepaid expenses divided by its current liabilities. Robinhood Markets's Quick ratio is 1.154, which indicates that that its total liquid assets are sufficient to meets its current liabilities.
Lastly, we consider Robinhood Markets's free cash flow of $-170000000. This is the sum of all of its incoming and outgoing cash flows -- including those that are unrelated to its core business, such as rent, legal costs, income from investments, debt payments, etc. A negative cash flow for a single quarter is not a particularly serious issue for a company that does not pay a dividend. But if the cash flows are negative or erratic over several years, the company may be in trouble.
Shares of Robinhood Markets appear to be overvalued at today's prices — despite the positive outlook from analysts. But sometimes stocks with inflated valuations turn out to be strong performances for years, and even decades, such as Amazon. So be sure to do your own due diligence if you are interested in taking a long position in HOOD.
