Fitbit: Stay Away

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About: Fitbit, Inc. (FIT), Includes: GOOG, GOOGL
by: Mauro Solis
Summary

Fitbit might not reach profitability.

The high end of the market is getting even more competitive.

The sunny side of the estimate could give a 16% annual return, but is highly unlikely.

Fitbit (FIT) is expected to perform seriously bad in 2019, and the market estimates it will be performing dreadfully in the following years.

Investing in the company presents a dangerous risk-reward proposition with unfortunate downside and terrible upside potential, and as for its price, it is dreadfully overvalued.

Fitbit is a small-cap company with a market cap of about $810 Million with favorable financials. Google (GOOG)(GOOGL)'s increasing push in wearables could be the critical factor that moves the valuation to the lower end of the spectrum.

Wear OS

Google is pushing wearables heavily, and there are a lot of innovations that will reduce the price of smartwatches or change the wearable industry. Fitbit will have trouble keeping up. While fit bit has had some interesting products, it has not been able to grow a significant moat and the Google Assistant, Kai OS, and the Soli chip will be the nails that seal the coffin.

Source: CNET

Kai OS has targeted the low end of the smartphone business by leveraging the Google Assistant and significantly reducing the cost of hardware. In that same way, Google is using the assistant to enable manufacturers to reduce the cost of the devices.

So Fitbit will have to compete against the Google Assistant and lower prices at the low end of the market. On the high end of the spectrum, the competition seems even more difficult.

The Apple Watch is selling very well, and the Soli chip that is rumored to be included in the Pixel Watch will likely spark interest in the high end of the Android Smart Watches.

Source: Gadgets

The Pixel Watch has been rumored since last year, and Google will likely launch three products. The launch could have been canceled last year because of the Soli Chip hadn´t been approved by the FCC. With the Soli chip and other synergies with project baseline and other Verily technologies.

Valuation

For the past years, revenue growth has oscillated from -24.5% and 149.5%, and the trend has been negative. The prediction estimates average revenue growth of 2.2% compared to the past average of 33.3%. The gross margin has had a minimum, and a maximum of 39.4% and 52.3%, and the trend has been decreasing. The next few years, the company will likely continue to decline in gross margin.

Source: Author's Charts

While R&D as a percentage of revenue has been between 7.3% and 22.1% with a tendency to be decreasing. The prediction estimates an average R&D as a percentage of revenue of 18.9% compared to the past average of 14.7%. G&A as a percentage of revenue has had a minimum and a maximum of 19.5% and 33.2% with a tendency to be down. The prediction estimates an average G&A as a percentage of revenue of 22% compared to the past average of 27% with those estimates we have the following chart.

Source: Author's Charts

These approximations are in line with the market expectations for Fitbit in the next couple of years, as the image below shows.

Source: Seeking Alpha

I like to use Peter Lynch's ratio when valuing a stock. This method uses the ratio between the expected earnings growth plus dividends and the P/E of the stock to determine its fair value. A stock that has a 1:1 ratio is reasonably priced. The higher the number, the more underpriced the stock is.

Source: Author's Charts

This valuation does not take into account the assets and liabilities of the company. The growth considered in the assessment is the average yearly growth of the next years, taking as reference non-GAAP earnings.

Constructing an adjusted Beta Pert risk profile for the long-term prospects of the stock, we can calculate the risk profile for the company.

Source: Author's Charts

The risk profile shows there is an 84.98% probability that Fitbit will ever trade at a lower price than it is today. Considering the potential downside, upside, and the likelihood of each, the statistical value of the opportunity of investing now, is of -13.6%.

Let's explain in greater detail the statistical value of the opportunity to invest in a company. The statistical value is the sum of all the possibilities of an event or a proposition, multiplied by their respective output.

Betting heads on a coin flip, where if you win, you will get 100% return, but if you lose, you will lose 100%, has a statistical value of 0%. If someone were to bet an infinite number of coin flips, they would end up with the same money they began with.

https://static.seekingalpha.com/uploads/2019/7/3/48398079-1562182369191027.png

On the other hand, if the odds of the coin flip were heads, you win 200%, and tails, you lose 100%, the statistical value of the bet would be 50%.

So in the short term, the company could increase its price dramatically, and in the long run, it will likely perform marvelously well.

Conclusions

Although the level of debt is reasonable, the potential upside is significant, the last year´s performance is steady and the past years performance is satisfying the company has many problems, the level of risk is terrible, the expected return for next year is horrible, the risk-reward is awful, and the expected performance for the foreseeable future is bland.

Google´s push in wearables will chip away revenue from Fitbit and reduce significantly any pricing power that Fitbit has. With decreasing gross margin, decreasing revenue, the company will struggle to reach profitability and to build a strong moat. The company does not have a clear market or niche where its products flourish, which makes it unclear where it is planning to go and where will it put its R&D on.

If there is anything in this article, you agree or disagree with or would like me to expand further on; I would sincerely appreciate you leaving a comment. I will address it as soon as possible.

Disclosure: I am/we are long GOOG, GOOGL. 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.