Peloton (PTON -0.98%) first attracted my attention when I noticed that sales doubled yearly even before the pandemic's onset. Of course, the outbreak put fuel on the fire, and growth surged higher still. I bought the stock with the realization that sales might slow down in the aftermath of COVID-19.
What I didn't anticipate were several decisions by management that would harm the business's long-term prospects by burdening it with a higher cost structure. After I saw the outcome of those decisions on the business's financials, I sold my shares at a loss.
What follows is a closer look at why I bought shares in the first place and why I am not repurchasing even in the face of the dramatic crash of the stock price.
Image source: Getty Images.
I sold Peloton stock at a loss after overinvestment from management
Peloton's sales increased by 99% in 2018 and 110% in 2019. In other words, the business doubled two years in a row, even before the outbreak of COVID-19 sent millions of people home. And even though the company was supply-constrained during the pandemic, sales increased by 99% in 2020 and 120% in 2021.
More importantly, the growth in scale made Peloton profitable on the bottom line. From here on out, I thought, even if sales growth decelerates, as long as it's positive, it should work to increase profits in the years ahead. Here's where I bought the stock. I was attracted to the rapidly growing sales and demonstration of economies in scale.
What's more, I liked the business and thought the customer value proposition was solid. After all, with Peloton, you can complete your daily exercise in the comfort of your home. That removes the inconvenience of driving to your local gym, looking for parking, and finding suitable machines to fit your routine.
Unfortunately, my anticipated scenario did not play out. During the surge in sales demand, management invested aggressively in increasing capacity, which significantly increased operating expenses, and profits quickly sank into negative territory. Moreover, because the expenditures were fixed in nature, they are challenging to cut in a hurry.
In contrast, if the rise in costs were simply from an increase in advertising, management could quickly decrease the spending in the next quarter. That's not so simple when investing in manufacturing facilities with long-term leases or rent payments. Here is where I sold the stock at a considerable loss.
PTON Net Income (Quarterly) data by YCharts
I was unwilling to hold shares while management figured out how to reduce expenses enough to match the lower-than-expected sales. To its credit, management has developed a plan that is expected to reduce operating expenses by $800 million annually, and former CEO John Foley has stepped down after taking responsibility for the missteps.
Peloton stock crashes
PTON PS Ratio data by YCharts
Peloton's stock crash has it trading at a price-to-sales ratio of 1.8, the lowest it has sold for in its brief history as a public company. Still, I am not buying shares after the fall. I may consider investing in Peloton again, but only after it delivers on its plan to cut costs and improve profit margins. The company would need to sustain healthy profit margins for several quarters before I feel confident the changes can be long-lasting.
Nevertheless, I am a fan of the business and the mission, and I am rooting for its success, albeit as a spectator rather than an owner.
