Peloton Interactive (NASDAQ:PTON) will report its fiscal second-quarter earnings results on Feb. 5, and investors seem optimistic based on the stock performance since its IPO last September. The stock is currently sitting about 20% above its IPO price and trades at a high valuation of 8.3 times sales. 

There is a lot going on at Peloton right now. It's investing in several different areas, including recently expanding into Germany and building up its digital content for connected fitness subscribers. With so many moving parts, there is the possibility that Peloton could report results that are either well above or below what analysts expect.

Instead of getting caught up in the earnings expectation game that Wall Street plays, I believe investors with a long-term mindset should focus on subscriber growth and the subscriber churn rate when Peloton releases earnings. Here's why.

A woman wearing workout clothing and stretching.

Image source: Peloton Interactive.

1. Subscriber growth

Peloton's basic strategy is to sell a connected fitness product to get customers subscribed to its digital fitness service. It's through subscriptions that the company aims to build up its profitability over time. While sales of bikes and treadmills earn a gross margin of 43%, subscriptions generate a gross margin of 56.1%. 

Building brand awareness and relying on word-of-mouth referrals is one way management is looking to bring marketing expense down and guide the business to profitability. This strategy is heavily dependent on growing its subscriber base as much as possible.

But another way Peloton can reach profitability down the road is by leveraging its operating costs. In the fiscal first-quarter shareholder letter, management stated, "A significant portion of our content creation costs are fixed given that we operate with a limited number of production studios and instructors." 

Investors want to see Peloton reach profitability. Peloton is saying it can do that by continuing to grow its subscriber base so that more revenue can be spread over the costs of a fixed number of studios and fitness instructors.

For the fiscal second quarter, Peloton expects its connected fitness subscriber base to reach 680,000 to 685,000, representing year-over-year growth of 88% at the midpoint. 

2. Subscriber churn rate

Obviously, subscriber growth doesn't mean anything if those members are not sticking with it. So, investors will also want to keep an eye on the average net monthly connected fitness churn rate, which basically indicates whether customers are happy with their Peloton product and fitness classes.

The churn rate has been looking very healthy for Peloton. The average monthly churn was just 0.90% last quarter, but it will tick up in the fiscal second quarter. This is because Peloton just launched a new home trial option that allows customers to test the product before committing to a purchase. 

The winter is usually the peak season for engagement with Peloton's fitness classes, as customers tend to stay indoors for their workouts. But the home trial opens the door for potentially more customer returns, so management is calling for the monthly churn to tick up to 1.05% in Q2 and remain at that level over the next few quarters. 

Perhaps the better metric to watch is the 12-month retention rate, which reduces the quarterly noise. The retention rate was 94% last quarter and management expects it to remain at that level in Q2. This means only 6% of new customers are dropping their subscription after a year.

Peloton's churn rate is one reason investors are optimistic about its growth prospects. The average retention rate at traditional fitness studios is 75.9%, according to the Association of Fitness Studios. Peloton estimates there are 62 million people with gym memberships in the U.S. alone. If a quarter of those drop out, that's an immediate addressable market for Peloton to go after.

It's very encouraging that not only has Peloton seen its subscriber base more than double over the last year, but those members are using their bikes and treadmills more frequently every month. Average monthly workouts per subscriber have improved from 7.4 in fiscal Q2 2018 to 11.7 in the fiscal first quarter of 2020.

Stay focused on what matters

Fast-growing companies that are unprofitable and investing heavily in growth can be difficult to value. This explains why growth stocks like Peloton can be volatile at times. 

If subscriber growth continues to remain robust and churn rate remains low, Peloton will remain on track to reach profitability eventually and support the stock's high valuation.