Fitness tracker maker Fitbit (NYSE:FIT) was a Wall Street darling last year, soaring from its IPO price of $20 to over $50 between June and August. But the stock has since plunged over 70% due to ongoing concerns that the company's high-growth days are over. I don't like to kick a stock while it's down, but I think the bears are right about this beaten-down stock for four simple reasons.
1. Slowing sales and earnings growth
Last quarter, Fitbit raised its full-year revenue guidance from 29%-34% growth to 34%-40% growth. That was encouraging, but it still represented a steep slowdown from 149% sales growth last year. Fitbit is also highly exposed to Brexit -- about 12% of Fitbit's sales come from Europe, and its most established market is the U.K.
Fitbit expects non-GAAP gross margins between 48.5%-49% for 2016, which would be comparable to its gross margin of 48.5% in 2015. However, rising operating expenses are expected to weigh down its non-GAAP net earnings, which are anticipated to rise just 5% to 16%. Comparing that estimate to Fitbit's forward P/E of 10 suggests that the stock isn't significantly undervalued relative to its earnings growth potential.
2. Rising competition
Between the first quarters of 2015 and 2016, Fitbit's share of the global wearables market fell from 32.6% to 24.5%, according to IDC. Xiaomi, the second biggest player, also saw its share slip from 22.4% to 19%.
Yet Apple's (NASDAQ:AAPL) share grew from nothing to 7.5%, thanks to the Apple Watch. Chinese newcomer BBK, which sells kids' smartwatches, saw its share rise from nothing to 3.6%. Market share for the "others" category rose from 33.1% to 37.2%, suggesting the market is becoming increasingly fragmented. Under Armour (NYSE:UAA) also recently entered the market with HealthBox, a $400 bundle that includes a fitness tracker, wireless scale, and heart rate strap tethered to its mobile app.
3. Plummeting prices
That competition has caused price expectations to plunge across the market. Xiaomi's Mi Band 2, which costs just $40, offers the same activity tracking features as Fitbit's $100 Flex but adds heart-rate tracking -- a feature only found in Fitbit's pricier devices. Misfit, which was acquired by Fossil last year, sells a wide range of wearables that cost under $100.
To escape that commoditization, Fitbit is pivoting toward stylish, higher-end devices like the $130 Alta and the $200 Blaze, which generated nearly half its revenue last quarter. The Alta and the Blaze can both display the time and other information, but they aren't full-featured smartwatches -- which is problematic because the price of the average smartwatch has fallen below $200. Piper Jaffray analyst Erinn Murphy recently noted that average prices of Fitbit devices had declined year over year on Amazon, and that excess inventory was appearing on flash sale sites.
Fitbit believes it can carve out a niche market in stylish sports performance devices, but that could be tough if comparably priced smartwatches offer similar features with access to many more apps. Meanwhile, more fashion-oriented smartwatch buyers could gravitate toward the Apple Watch instead.
4. Redundant devices
In addition to cheaper fitness trackers and smartwatches, Fitbit has to worry about newer smartphones rendering stand-alone trackers obsolete. Most smartphones can now track a user's movements through motion sensors, motion co-processors, and GPS. That's how apps like Apple Health and Google Fit track steps without syncing to a wearable device.
For people who just want to take a quick walk or jog around the neighborhood, these apps generally work well enough. Moreover, smartphones can now use cameras to monitor a user's heart rate -- which might also be enough for users who don't need constant updates on their cardiac activity.
The key takeaway
Fitbit's biggest flaw is that it's a hardware maker selling devices that are easily replicated and commoditized. To make matters worse, it's being crushed between two distinct markets -- the low-end fitness tracker market and the high-end smartwatch one. As prices for smartwatches fall, the two markets will converge and likely leave Fitbit stuck in the middle of a commoditized market.
Leo Sun owns shares of Amazon.com. The Motley Fool owns shares of and recommends Amazon.com, Apple, and Under Armour (A shares). The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool recommends Fitbit and Fossil. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.