Investors knew the near term was going to be challenging for Peloton Interactive (NASDAQ:PTON), but the latest earnings results and forward guidance leave a lot of uncertainty about Peloton's competitive position.

While subscriptions continued to grow at a brisk pace, sales of bike hardware came to a screeching halt last quarter, causing management to lower Peloton's full-year guidance.

As a result, the stock got crushed last week. Still, the shares trade at a high valuation relative to the company's expected growth rate for fiscal 2022. Here's why Peloton is a falling knife I wouldn't touch right now.

A person using an exercise bike.

Image source: Getty Images.

Peloton is facing several challenges

Total revenue grew 6% year over year for the quarter, which is not bad, considering the extremely difficult comparison with the year-ago quarter's 232% revenue growth rate. However, all that growth was driven by higher connected fitness subscriptions, as well as growth in digital app subscriptions. Sales of Bike and the effect from the Tread recall caused product revenue to fall 17% year over year.  

These results might have been better received by investors if not for one comment by management during the earnings call. CEO John Foley cited a "greater-than-anticipated taper" of website traffic over the last few months and a slower recovery in retail showroom traffic. "This reduction in traffic has added increased near-term uncertainty into our forecast," he said. 

More disappointing is that this decline comes after a price reduction on the original bike model. While management saw a lift in its e-commerce conversion rate after the price cut, it wasn't enough to offset the declines in traffic.

This is not the outcome investors wanted to see, especially with competition increasing from other hardware manufacturers, such as NordicTrack maker iFit Health & Fitness or Nautilus. There's really not a lot that differentiates a Peloton Bike from a NordicTrack, which forces Peloton to spend more on marketing and the additional costs could weigh on profitability longer than investors expect.

The combination of price-cutting, decelerating traffic, and higher marketing spending contributed to a large loss on the bottom line last quarter. After seeing net profit margins reach nearly 15% in fiscal fourth-quarter 2020, Peloton reported a net loss of $376 million in the most recent quarter. This is significantly lower than before the pandemic, when Peloton was a smaller business generating less revenue.

Chart showing recent drop in Peloton's net income and revenue.

PTON Net Income (Quarterly) data by YCharts

Considering the erosion on the bottom line, management said that "we will be taking concrete steps to reexamine our expense base and adjust our operating costs to better align our investments with our revised growth expectations." It certainly added a lot of doubt about Peloton's competitive position right now when it raised marketing spending to 35% of revenue, up from 25% in the previous quarter, and still delivered lower-than-expected revenue growth.

Why the stock hasn't hit bottom yet

One silver lining of the quarter was that connected fitness subscriptions grew 87% year over year to 2.49 million, and the 12-month retention rate remained steady at 92%. Peloton can still grow, but the question is at what rate. Investors are not sure right now.

Management lowered its full-year guidance and now expects revenue to grow just 14% over fiscal 2021. The increasing competition and price cuts raise uncertainty about Peloton's sustainable growth rate beyond the pandemic, and the lower guidance doesn't provide investors enough confidence that Peloton can grow fast enough to justify its expensive valuation.

Even after the recent sell-off, the stock trades at a price-to-sales (P/S) ratio of 3.9. That is way down from the P/S multiple of 20 earlier this year, but it still looks expensive in light of Peloton's recent performance. A P/S ratio of 3.9 is basically a normalized price-to-earnings ratio of 39, assuming Peloton's long-term profit margin can settle around 10%.

With management expressing uncertainty about near-term demand, on top of mounting competition, it's difficult to say what Peloton's growth rate will be beyond fiscal 2022. Because of this, the stock could continue to fall until its valuation reflects lower growth expectations.

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.