With gyms shut down and stress piling up, people across the world have turned to online, virtual fitness classes as a way to stay fit and cope. Hugely popular home workout brand Peloton (NASDAQ:PTON) has grown by leaps and bounds since its debut on the stock exchange, and the latest quarters have been no different. But is such a young company really worth so much? 

When net losses are not losses

Peloton's subscription and equipment sales have roughly doubled every year recently, with slightly faster growth in subscription revenue (on average). Despite the resulting 735% increase in total revenue over the past three fiscal years, Peloton consistently posted net losses until its latest quarter. Gross margin was a solid 45.8% in the company's recently-completed 2020 fiscal year, but management has been investing heavily in marketing, as well as general and administrative expenses. This kept its net profit margin at -3.9% in fiscal 2020.

A younger woman follows a Peloton online class to work out in her living room.

Image source: Peloton.

However, Peloton has been reducing its net losses as a proportion of total revenue since going public. Management's strategy in prioritizing growth over earnings has really paid off over the past year. In the fourth quarter of fiscal year 2020, the company posted a net profit of $89.1 million, cutting its annual net loss to -$71.6 million in fiscal 2020 from -$195.6 million the year before. Furthermore, Peloton turned cash flow positive in fiscal 2020, generating $220 million of free cash flow.

Cashing in on younger customers

Peloton garnered much notoriety with its 2019 Christmas ad featuring a middle-aged white man gifting his partner a stationary bicycle, but in recent quarters, the company has actually been targeting a younger cohort. With more than 3.1 million subscribers in June 2020, Peloton reported that its fastest-growing age group is under 35 and its fastest-growing household income bracket is less than $100,000.

Peloton graphic showing how its sales conversion works.

Source: Peloton May 2020 presentation (slide 11).

This has huge implications for the company, as younger users are more likely to recommend their favorite brands on social media, improving Peloton's brand awareness and market penetration. For example, 90% of Instagram users are under 35 -- Peloton's fastest-growing user age group -- and recent data indicates that 90% of active Pinterest users make purchase decisions based on pins they browse.

A younger subscriber might not be willing or able to buy the company's expensive equipment -- which runs $1,895 for the lowest-tier bike up to $4,295 for the Tread+ -- and may only subscribe to Peloton's $12.99 per month online classes. However, those users may later decide to buy Peloton fitness equipment, thereby increasing average revenue per user. And, of course, the longer a user remains a subscriber, the more lifetime revenue the company is able to earn.

Is it worth the price?

So ultimately the question remains: Is Peloton really worth a whopping $24 billion?

Peloton stock is currently trading near all-time highs, around $85 a share, up from a March 2020 price of $20. However, the company's revenue growth has been truly extraordinary. Last quarter, revenue jumped 172% year over year to $607.1 million, beating Peloton's own estimate by about $100 million. For fiscal 2021, the company expects total revenue to roughly double again to between $3.5 billion and $3.65 billion.

On projected revenue alone, Peloton appears to easily meet shareholder expectations. Nevertheless, the question of profitability is still up in the air. The company has not released an estimate as to when it expects to achieve a full-year net profit, but its free cash flow improved steadily over the past two years and finally turned positive in 2020. If this trend continues, full-year profitability might not be so far away.

Overall, Peloton is a very trendy and enticing growth stock. If an investor is patient and can afford to wait for the company to consolidate its position, then Peloton could be a reasonable stock to add to a balanced portfolio. However, a lot of its value depends on maintaining its popularity, and with the rate of change in our fast-paced society, the company could be facing a bumpy road to even more success.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.