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1 Tech Stock to Avoid at All Costs

By Prosper Junior Bakiny - Oct 14, 2019 at 7:46AM

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This once-leading producer of wearable devices is in hot water.

The tech sector is home to a plethora of excellent investment opportunities. These include established companies such as Amazon and Apple and up-and-coming innovators such as Shopify and Square, to name only a few.

But in the midst of all those tech success stories reside other companies that couldn't make the cut and found themselves at the bottom of the barrel. One such company is Fitbit (FIT). The once-admired producer of fitness technology devices has delivered consistently mediocre performances in recent years, and there is no sign that things are about to take a turn for the better. 

fitness tracker

Image source: Getty Images.

Competition is killing Fitbit

In many ways, Fitbit was a pioneer in its particular segment of the market. The company was one of the first to offer wearables, which were such a success that Fitbit managed to attract a loyal following. However, other tech companies quickly understood the opportunities the wearables market offered and decided to join the fun.

Apple led the charge in the quest to disrupt Fitbit's market by offering similar devices. Fast-forward a few years, and Apple's wearables business is booming. During a conference call to discuss the company's third-quarter results, Apple CEO Tim Cook spoke highly of this business segment: "We saw ... an absolutely blowout quarter for wearables where we had accelerating our growth of well over 50%." Cook went on to say that Apple's wearables business is now "bigger than 60% of the companies in the Fortune 500." Clearly this doesn't bode well for Fitbit or its shareholders.

As if competition from one of the most valuable brands in the world isn't enough, Fitbit is also trying to fight off other competitors, most notably Huami, a Chinese company that went public earlier this year. Huami manufactures Xiaomi's fitness tracking devices and other products such as smartwatches. Comparing Huami's recent financial results with those of Fitbit is instructive. 

During the second quarter, Huami reported revenues of $151.3 million, a 36.6% jump year over year, whereas Fitbit reported top-line growth of just 4% for a net revenue figure of $313.6 million. While Fitbit's adjusted gross margins were higher than Huami's -- 35.6% vs. 26.5% -- Huami's margin levels rose a percentage point, while Fitbit's declined by about five percentage points from year-ago levels. Finally, Huami is already profitable, delivering a net income of $13 million during the quarter, while Fitbit recorded an adjusted net loss of $35.8 million. Perhaps one quarter alone isn't enough to draw definitive conclusions about the direction of both companies, but one thing is for certain: Fitbit's market won't become less competitive anytime soon. 

Between a rock and a hard place 

Fitbit may have a loyal customer base, but unless the company can manage to attract new customers -- or find more profitable ways to milk its community of active users -- strong top-line growth and consistent profitability will continue to elude it. Attracting new customers won't be easy, though, with competitors such as Apple and Huami lurking. Apple can leverage its equally strong customer base to rally further over Fitbit, while Huami offers the perk of lower-priced items. This leaves Fitbit in a difficult position, and the company can and did try introducing cheaper items to gain new customers. 

As Fitbit noted in its second-quarter earnings release, unit sales were up 31% from year-ago levels, but average selling prices were down 19% due to less expensive devices. The company attributed that to trying to "lowering barriers to joining our community of active users," but this trend of weaker margins to entice greater sales volume is projected to continue for the foreseeable future. Trying to build a strong community and focusing on that side of the business equation may turn out to be fruitful somewhere down the line for Fitbit, but note that during the second quarter, accessory and nondevice revenue represented only 3% of the company's revenues. 

In other words, there is no sign that Fitbit can pull off this turnaround, which makes the company's prospects especially dim, at least at the moment. 

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Prosper Junior Bakiny owns shares of Shopify. The Motley Fool owns shares of and recommends Amazon, Apple, Fitbit, Shopify, and Square. The Motley Fool has the following options: short January 2020 $70 puts on Square, short January 2020 $155 calls on Apple, long January 2020 $150 calls on Apple, short January 2020 $155 calls on Apple, and long January 2020 $150 calls on Apple. The Motley Fool has a disclosure policy.

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