Choosing a single top stock is a dangerous proposition. Part of being a good investor is recognizing your own fallibility -- we don't always get it right. For this reason, instead of concentrating around a single pick, diversifying across multiple stock ideas will often yield better long-term results as winners offset losers and drive overall returns.
Perusing the top 100 stocks on brokerage app Robinhood yields many great investment ideas, including PayPal, Amazon, NVIDIA, and more. These are all quality companies that I believe investors should research and consider buying.
But after much deliberation, I can't stop thinking about Peloton Interactive (PTON +1.57%) as a top buying opportunity right now. And it has a lot to do with the company's (underappreciated) optionality for the future.
Image source: Peloton Interactive.
What's optionality and where did it come from?
Optionality increases the market opportunity of companies. Sometimes visionary management positions a business for future innovation, as we'll see in Peloton's case in a moment. Other times, optionality allows a company to expand its market with ancillary products right now.
Peloton's treadmill (simply called "Tread") is this second kind of optionality. Until 2018, the company only sold stationary bikes (called "Bike"). But it expanded its market opportunity by developing the Tread product line to build on the success it achieved with Bike. According to Allied Market Research, the global treadmill market is more than double the size of the exercise bike market. Therefore, it's important to exercise optionality in this way.
Peloton owes its ongoing potential for optionality to two things. First, its core business is performing quite well. Consider that in the fiscal third quarter of 2021, its most recent quarter, average workouts for Peloton subscribers hit an all-time high of 26 per month, and churn (how many subscribers it's losing) hit a six-year low. Second, it's in an enviable financial position, with roughly $2.7 billion in cash.
Because Peloton doesn't need to fix its core business or scramble to stay liquid, it has the luxury of pursuing ways to expand. And indeed, that's what it's doing.
Image source: Getty Images.
Planting seeds of optionality
Investors have paid a lot of attention to Peloton's acquisition of Precor, and for good reason. At $420 million, it wasn't cheap. But the company has made three other acquisitions in the past year that investors should be aware of as well. According to Bloomberg, Peloton has quietly acquired Otari, a maker of connected yoga mats; voice-to-action platform Aiqudo (think Amazon's Alexa); and fitness-tracker company Atlas Wearables.
Otari was a crowdfunded project last year. The company hoped to deliver an experience similar to Peloton's by allowing users to stream yoga classes. But the screen also contained a camera to analyze your movements and give personalized, corrective instructions to improve yoga form. These three acquisitions certainly appear to outline management's game plan. I expect it will launch connected-fitness hardware for yoga in the next few years, building and improving on Otari's idea.
However, Peloton's management might have a more visionary plan. Maybe it can bring Otari's strengths to its entire connected-fitness experience. Perhaps a camera on Bike and Tread, or a wearable device, could analyze individual workouts, shouting corrective commands or motivators to users in real time. Other at-home fitness companies are already emulating Peloton by offering subscriptions to video content and gamification features. But offering a real-time, personalized workout experience would truly be innovative and could keep Peloton a step ahead of the competition.
Why I love optionality
It's important to note that optionality opens companies, Peloton included, to new downside risk. This was illustrated with Tread. It turns out this product was unsafe, requiring the company to pause sales and issue a recall. Management expects a $165 million hit to revenue as a result, to say nothing about profitability. Moreover, there's fair reason to criticize management's initial response to safety concerns, which is bad news for a company trying to achieve a perfect net-promotor score of 100.
Maybe some investors feel like Peloton should have just stuck to Bike. However, to be a good long-term investment, it has to find ways to grow its addressable market. Consider that its market capitalization is already $36 billion. Even with strong user metrics, the growth potential for this business would be very limited if it only sold stationary bikes, making its current valuation look absurd.
As we've seen, Peloton is both in a position to exercise optionality and is demonstrating willingness to do so. Therefore, I'd be reluctant to underestimate just how big this business can be in the long term. It has the underappreciated flexibility to expand its market opportunity, and that's why Peloton is a top stock to buy in my opinion.
