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Fitbit and Garmin Leave Investors Unimpressed With Their Latest Reports

By Nicholas Rossolillo – Nov 18, 2016 at 8:37AM

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Wearable sales grew for both companies, but neither stock reacted how you might have expected them to.

Fitbit (FIT) and Garmin (GRMN 0.87%) are two of the hottest wearable-tech companies. Both companies recently reported third quarter 2016 earnings, and despite solid sales growth, investors were unimpressed at best.

Let's take a closer look at the latest developments for both companies as they enter the holiday season.

Fitbit reports growth again but with important footnotes

Image source: Fitbit.

The leader in connected fitness watches had another knockout quarter, with revenue increasing 23% year-over-year to $503.8 million. Revenue is up 39% through the first nine months of 2016. CEO James Park announced that his company has sold 54 million devices since its founding in 2007.

Fantastic news, right? Wrong! Fitbit shares tumbled 30% following the report. The problem was the company downgraded its outlook for the all-important holiday shopping season, and as a result, it sharply downgraded its full-year outlook for sales.

The company now sees sales in the fourth quarter increasing only 2% to 5% from last year. That lowers the projection for full-year growth to approximately 25%, down from the 39% pace delivered so far this year.

Fitbit is running into some resistance as sales in North America, its primary market, begin to slow down. Even though the last quarter sported double-digit revenue expansion, sales of new devices increased only 11%. Contributing to the other half of the picture was an 11% increase in average selling prices.

Also major source of concern: Asia sales declined 45%. The region is largely untapped, making up only 7% of revenue last quarter, and it represents a big area of opportunity going forward. Management cited marketing issues and said it will focus on refining its message to rekindle growth there.

On top of those issues, the explosive growth to date has come at a cost for the wearable maker. For the 2016 year-to-date, earnings per share of just $0.18 is down significantly year-over-year from $0.48. Research and development costs have more than doubled, and the cost of sales and marketing expenses also went up 70%. In spite of that increased spending, sales are sputtering anyway.

Garmin wearables are a hit, but old business is an anchor

Image source: Garmin.

The GPS-reliant company reported revenue 6% higher than last year, a welcome change of pace as Garmin has been stagnant in that department in years past. Leading the way were the fitness and outdoor categories, both of which are dedicated to a portfolio of wearable devices. The two categories were up 32% and 28%, respectively, over the third quarter of last year. Earnings per share followed suit and improved 5%.

As a result, the company also slightly increased full-year guidance. Revenue expectations were bumped up to $2.95 billion from previous estimates of $2.9 billion, and earnings per share went up to $2.65 from $2.50.

This good news was also met with investor skepticism. Garmin shares initially declined about 4% before recovering.

What was the worry? The company's bread-and-butter, the automotive division, has been in decline all year, and this quarter saw a 21% drop in sales. Through the first nine months of the year, Garmin's largest segment is down 17%. So while wearables are a hot-selling and increasingly profitable item for the company, it is fighting an uphill battle and is essentially only replacing lost business.

With automotive equipment sales expected to continue declining, Garmin's upside has been capped. This is especially the case when considering the stock has already notched a nearly 50% gain from this time last year. The business improvement has already been priced in at this point.

What investors should consider

Wearables have been a hot-selling item, but with that comes very high expectations from investors. Despite turning in solid growth from smart watches and connected fitness devices, both Fitbit and Garmin got hit with the "when good is just not good enough" problem. Simply put, buying into a high-growth market is not necessarily a slam-dunk proposition.

Garmin stock doesn't interest me much. After this year's gains, valuations are high with price-to-earnings at over 19 times and profitability being dragged down by the automotive division. Fitbit is a little more intriguing after its steep trade-off, and the company has only just begun breaking into markets outside the United States. I expect a bumpy ride for shareholders, though, as Fitbit hasn't yet found the right recipe for driving growth in Asia, and profitability will probably be volatile due to elevated spending on R&D and marketing.

Nicholas Rossolillo has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Fitbit. 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.

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