Shares of Fitbit (NYSE:FIT) recently plunged after the wearables maker posted its fourth-quarter earnings. Its revenue rose just 0.1% annually to $571.2 million, which beat estimates by less than $2 million.

Fitbit posted a GAAP profit of $15.4 million, compared to a loss of $45.5 million a year earlier. On a non-GAAP basis, the company generated a profit of $36.3 million, compared to a loss of $4.7 million a year ago. Its non-GAAP EPS came in at $0.14, which topped expectations by $0.07.

Fitbit's Versa smartwatch.

Image source: Fitbit.

Fitbit's total device shipments rose 4% to 5.6 million, but its average selling price dropped 2% to $100, even as it pivoted its product mix toward pricier smartwatches. As a result, its non-GAAP gross margin contracted 550 basis points annually to 38.7%.

Fitbit expects its revenue to rise 1% to 8% annually for the first quarter, compared to the consensus forecast for 10% growth, as its non-GAAP gross margin contracts to 34% to 35%. It expects to report a non-GAAP loss of $0.22 to $0.24 per share -- which also misses the consensus forecast for a loss of $0.15 per share.

That bleak outlook indicates that Fitbit, which trades at a 70% discount to its IPO price, could still face more pain in the crowded wearables market. However, value-seeking investors might still consider Fitbit a contrarian play since it still has a strong brand and trades at just 1.1 times this year's projected sales.

What happened to Fitbit?

Fitbit was once the top wearables maker in the world. However, its first-mover advantage faded as challengers like Xiaomi introduced cheaper fitness trackers and companies like Apple (NASDAQ:AAPL) rendered basic trackers obsolete with full-featured smartwatches.

As a result, Fitbit's market share fell from 13.7% to 10.9% between the third quarters of 2017 and 2018, according to IDC, which put it in third place behind Xiaomi and Apple. Fitbit didn't want to sacrifice its margins to compete against Xiaomi in the low-end market, so it launched the smartwatch-like Charge 3, the Versa smartwatch, and the Ace for kids.

That trio of devices generated 79% of Fitbit's revenue during the fourth quarter, but the company's flat revenue growth and declining average selling prices indicate that there simply isn't enough demand for these devices.

Fitbit's Versa smartwatches

Image source: Fitbit.

Meanwhile, Strategy Analytics recently reported that global shipments of Apple Watches rose 18% annually to 9.2 million units during the fourth quarter, giving Apple a 51% share of the world's smartwatch market. Fitbit, which claimed 13% of the market, ranked third after Apple and Samsung.

Apple's strength can be attributed to the launch of the Series 4, the tight integration of its Watches with its iPhones, and its expanding ecosystem of watchOS apps. Fitbit's App Gallery hosts fewer apps, and its users probably aren't as dedicated to a single brand as Apple's users.

Only 38% of Fitbit's product activations came from repeat customers in 2018, compared to 37% in 2017. This suggests that Fitbit's customers aren't loyal to the brand (like Apple's customers) or eager to upgrade their existing devices. This means Fitbit will likely need to slash prices, even on its higher-end smartwatches, to boost its shipments and revenue again.

A dim outlook and limited catalysts

For the current year, Fitbit expects its device shipments to rise slightly and for its revenue to rise 1% to 4%. However, it also expects its average selling price to decline and for its adjusted EBITDA to come in between a loss of $0 to $30 million.

That would mark an improvement from its adjusted EBITDA loss of $31.4 million in 2018, but it will likely be caused by reduced operating expenses (including layoffs and lower marketing expenses) instead of expanding gross margins. In other words, Fitbit could be slashing its R&D and marketing spend at a time when it desperately needs to launch new devices and strengthen its brand awareness.

Looking ahead, Fitbit's biggest growth market is the APAC (Asia Pacific) region, which partly offset its negative sales growth in other regions in previous quarters. However, the growth of its APAC revenue also decelerated significantly over the past year (excluding its flat growth in the third quarter) and accounted for a smaller percentage of its total sales.

Metric

Q1 2018

Q2 2018

Q3 2018

Q4 2018

APAC revenue growth (YOY)

33%

66%

0%

26%

Percentage of revenue

11%

12%

9%

9%

Data source: Fitbit quarterly reports. YOY = year over year.

This means investors shouldn't count on Asia to boost Fitbit's growth anymore, especially as the company cuts back its operating expenses.

The verdict: Avoid Fitbit

Fitbit remains relevant as a brand with its Versa, Charge 3, and Ace devices, but that doesn't make it a good stock to invest in. The company's core business faces brutal competition from bigger companies like Apple and Xiaomi, and it's cutting off its own hands with tighter cost controls. Investors who are interested in the wearables market should probably stick with Apple instead of taking a chance on Fitbit.