3 Dangerous Trends Robinhood Investors Are Chasing

When the curtain closes on 2020 in less than seven weeks, it’s bound to go down as one of the most volatile years on record for Wall Street.

For instance, the 124-year-old Dow Jones Industrial Average registered 14 of its 16 largest single-day point declines in history this year, with the broad-based S&P 500 losing 34% of its value in just 33 calendar days during the first quarter. Even though the S&P 500’s loss has been completely recouped (and then some), it’s remained a challenging year for investors.

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This heightened volatility has also attracted young investors who believe they can use the wild swings in the stock market to get rich quick. Online investing app Robinhood has signed up millions of millennial and novice investors this year. The average age of its users is only 31.

Robinhood draws users with its commission-free platform, gifts of shares to new members, and fractional-share investing. Getting millennials excited about putting their money to work is good. The earlier they start, the more time they have to build wealth.

But Robinhood has failed to educate its users about the benefits of long-term investing. Robinhood’s user base often chases short-term news or downright awful companies.

It’s no secret that Robinhood investors love growth stocks and beaten-down brand-name companies. Unfortunately, their inexperience has led them to chase after three especially risky investing trends.

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COVID-19 vaccine stocks

Robinhood investors really love the idea of buying into coronavirus disease 2019 (COVID-19) vaccine developers. Among the 100 most-held stocks on the platform, you’ll find the likes of Moderna (NASDAQ:MRNA), Johnson & Johnson, Pfizer (NYSE:PFE), Inovio Pharmaceuticals, Gilead Sciences, and iBio.

Earlier this past week, Pfizer and its development partner BioNTech dazzled Wall Street with the interim analysis of its phase 3 trial for BNT162b2 as a vaccine for SARS-CoV-2, the virus that causes COVID-19. This analysis showed that BNT162b2 is more than 90% effective. This result blew even the most aggressive expectations out of the water and appeared to validate Robinhood investors’ love for COVID-19 stocks.

But chasing after COVID-19 vaccine stocks can prove hazardous to your wealth for a variety of reasons.

Important data from Pfizer’s interim analysis is still unknown. Also, fewer than 2 in 5 experimental vaccines are successful in clinical trials. We’re likely to see a majority of the roughly two dozen COVID-19 vaccines in development fail to reach meaningful efficacy.

Even if vaccine developers succeed in clinical trials, financial success remains far from assured. This is a highly competitive space; in many instances, valuation premiums are baked into COVID-19 vaccine stocks. For example, Moderna was the first to begin testing its vaccine candidate, mRNA-1273, in human clinical trials. If its vaccine is approved and generates, say, $4 billion a year, Moderna would be valued at over 7 times peak sales, which is pretty expensive for a biotech stock.

The reality is that there are dozens of more intriguing indications for Robinhood investors to buy into besides COVID-19 vaccines.

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Since young investors have time on their side, growth stocks are typically their friends. Peruse Robinhood’s leaderboard, however, and you’ll find that it’s littered with slow-growing airline stocks like American Airlines Group (NASDAQ:AAL), Delta Air Lines, Southwest Airlines, United Airlines, Spirit Airlines, and JetBlue Airways.

Why airline stocks? My belief is young investors are attracted to their pulverized share prices. Additionally, the airline industry is cyclical, meaning it does quite well when the U.S. and global economy are expanding. Since periods of economic expansion last considerably longer than contractions and recessions, the airline industry might seem like a smart bet based on the numbers.

Unfortunately, this thesis fails time and again, with airline stocks proving to be toxic to investment portfolios. This is an industry with high capital inputs and margins that are mediocre at best — assuming the economy is chugging along on all cylinders. Airline balance sheets, especially for major players like American Airlines, are rarely built for prolonged periods of economic contraction or recession.

Worse, quite a few airline stocks were forced to seek COVID-19 relief loans from the federal government. Companies that chose to take this added liquidity (ahem, American Airlines) can no longer repurchase their own stock or pay shareholders a dividend. Airlines’ capital return programs were perhaps the only valid reason to even consider the industry for investment.

If you need more convincing, American Airlines is lugging around over $41 billion in total debt. Servicing that debt will hamper the company’s financial flexibility for many years.

Airline stocks are a one-way ticket to a grounded portfolio.

A cannabis leaf laid in the outline of the Canadian flag's maple leaf, with joints and a cannabis bud next to the flag.

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Robinhood investors are also playing with fire by chasing marijuana stocks.

There’s a very good chance that cannabis will be one of the fastest-growing industries this decade, which makes pot stocks intriguing opportunities. Yet there’s a big difference between investing in the U.S. marijuana market and in Canada’s legalized pot industry. Weed is federally illegal in the U.S., but it’s thriving at the individual state level. Meanwhile, Canada has legalized recreational pot, yet its industry is a regulatory mess. Investors should park their money in the U.S.

The problem? Robinhood has a fatal flaw: Its members can’t buy over-the-counter (OTC)-listed stocks. Since U.S.-based marijuana stocks can’t list on major U.S. exchanges, nearly all of the best investment opportunities in cannabis are on the OTC exchange.

Meanwhile, all the terribly performing Canadian pot stocks appear in the 100 most-held stocks by Robinhood users. These include Aurora Cannabis (NYSE:ACB), Canopy Growth, Tilray, Aphria, HEXO, Cronos Group, and OrganiGram.

Let me explain what Robinhood investors are getting themselves into by chasing the likes of Aurora Cannabis. Aurora Cannabis wrote down more than $2.8 billion Canadian in fiscal 2020 after grossly overpaying for a number of acquisitions and overextending its production capacity. The company has also ballooned its outstanding share count by 11,800% since June 2014, and its board recently approved a $500 million at-the-market offering that’ll allow it to continue drowning its shareholders in new issuances.

The marijuana universe that Robinhood investors can buy is downright dangerous.

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