'Robinhood Index 2019': Goodbye Micron, Hello Aurora

Summary

• Investors can see the top 100 holdings of users of the brokerage Robinhood that is popular among young people who are new to investing.
• My previous Robinhood Index underperformed the market as expected.
• The updated 2019 index now includes more weight toward cannabis companies and less toward chip makers.
• Financially, the companies in the 2019 index appear to be even more risky than last year's.
• The top holdings indicate systematic behavioral biases that may provide for a profitable short-equities strategy.

Last July, I wrote an article called "The 'Robinhood Index': Like FANG But Better" that showed the back-tested performance of the top 20 holdings in the increasingly popular investment brokerage Robinhood. Because the brokerage offers no commission trading, it attracts many Millennial and Generation Z investors who are new to investing and typically have a smaller account size.

Even more exciting, Robinhood lets the public see top 100 most popular stocks held among users. This lets us analyze "what the kids are up to" so we can better understand the investment strategy they pursue. Here is an updated list of the top 20 stocks held in Robinhood accounts:

1. Aurora Cannabis (ACB)
2. General Electric (GE)
3. Ford (F)
4. Microsoft (MSFT)
5. Apple (AAPL)
6. Fitbit (FIT)
7. GoPro (GPRO)
8. Cronos Group (CRON)
9. Advanced Micro Devices (AMD)
10. Tesla (TSLA)
11. Disney (DIS)
12. Snap (SNAP)
13. Canopy Growth Corp. (CGC)
14. HEXO Corp. (HEXO)
15. Facebook (FB)
16. Alibaba (BABA)
17. Zynga (ZNGA)
18. Plug Power Inc. (PLUG)
19. Amazon (AMZN)
20. Bank of America (BAC)

There are a few findings that are quite funny. First, roughly 20% of the top holdings are in the marijuana industry. Maybe it is because young investors believe widespread recreational legalization will occur, or perhaps it is simply due to a subconscious stemming from deluge of green found in the Robinhood UI.

The other interesting finding is that there is a very stark contrast between old and new firms. There are many fast growing pre-earnings companies like Aurora Cannabis combined with very old stocks like GE. Perhaps, they were given the popular advice to "hold a few time-tested blue chips and then play with the rest". Overall, it is clear that Robinhood users prefer well-known brand name companies that typically have higher growth at the cost of even higher valuations.

Another interesting figure is how the holdings have changed over the past year. Overall, most of the holdings are the same and many even have the same ranking. See below:

Note: Holdings are in order of popularity

Source : Robinhood Most Popular

As we can see, cannabis fever has officially replaced semiconductor/bitcoin fever. Last year, many investors on Robinhood bought semiconductors in hopes that cryptocurrency mining would spur huge demand for graphics processing units. Events in late last year proved otherwise. This year, they have put those hopes into the cannabis industry. It is almost unfortunate to see how much the retail investor oriented investment media promises vast riches when it comes to investing in marijuana companies. I have found Seeking Alpha is one of the few outlets where reasonable analysis is done on that industry.

Time will be the final judge, but it seems that many of these (typically new) investors have made their decisions based on personal interests and not on financial reasoning. In my opinion, that strategy will not make for good long-run returns.

Performance Review

Last year, I expected that, due to the extremely high valuations and risk of the Robinhood Top 20 Index, the index would underperform the market. Since July 23rd when that was published, the 2018 Top 20 Index is down 4% while the S&P 500 is up about 5%. Even more, during the depths of the crash last year, the index was down 30% since the article was written while the S&P 500 was only down 16%.

Here is a chart of the comparative performance of the new 2019 index vs. the 2018 index and the S&P 500:

Data source: Google Finance

What makes the 2019 index different than the 2018 index? The risk profile of the new index is even worse. Talk about a high volatility investment strategy; the annualized standard deviation for both the 2019 and 2018 indices is 19% while only 13% for the S&P 500.

The investment strategy can best be understood as performance chasing. That strategy does actually outperform the market in certain environments with high liquidity and a growing economy, but underperforms tremendously in a bear market.

Another way we can see this is by looking at the back-tested alpha generated by the strategy. To do this, we take the 2019 index and divide it by the S&P 500 performance that is scaled such that the volatility is the same for both. This lets us see if the current holdings have truly been out- or underperforming. We can expect that they will be outperforming as the 2019 index current holdings will likely have a bias toward stocks with strong recent performance.

Here is that chart:

Data source : Google Finance

As expected, we see that these current holdings have been the top performers in recent years. Interestingly, we can also see that they have been underperforming over the past few months as seen in the downtrend that begins around March of this year. To me this is another sign that investors in these stocks may be in for tumultuous returns going forward.

2019 Robinhood Index Fundamentals

Let's take a look at the fundamentals for these stocks and see if the investors are considering financial information.

Here is a snapshot of that data:

Source: Uncle Stock

Note: "Typical" denotes harmonic mean for "P/E", "P/R", "P/B", and current ratio. Median for Net Margin, and Revenue Growth. Mean otherwise. These are done in order to best illustrate typical values.

The typical P/E multiple for this set is 48X for the companies that make a profit. The other half do not make a profit. Speaking of which, the typical ROE is negative 10% and debt ratios are pretty high at a typical value of 56% given only one bank is included.

The only positive statistic is the high growth of most of the companies which have, on average, been growing their top line by 20% per year. That said, the only stocks included that I would be willing to go long on are Bank of America (BAC) and Disney (DIS). They may have less explosive growth potential, but at least I'd know what I'm buying.

Bottom Line

In my opinion, Robinhood top holdings are a highly underutilized tool available to investors and analysts. Not because the users of the broker are good investors, but because they seem to fall to cognitive biases and may even make for an alpha generating short-selling strategy.

There are known to be six of these major cognitive biases when it comes to investing. We can see three of them clearly among the "Robinhood Index":

1. Loss Aversion - We can see that the biggest losers of last year (semiconductors) were largely removed from top holdings.
2. Familiarity Bias - Clearly, Robinhood investors tend to buy popular brands that they use in their personal life.
3. Bandwagon Effect - Last year trading Micron (MU) was very popular. This year its Aurora Cannabis and other cannabis stocks. Chasing the herd is dangerous and creates bubbles.

I'll be keeping a close eye on this index and may update it with the top 100 most popular. Results from the test last year indicate that there may be a strategy here that delivers consistent underperformance due to those biases. Of course, one bad year is not enough to be proof, but I think we can clearly see that prudent investors may be best off avoiding the "most popular picks".

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Disclosure: I am/we are short AMD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.