Peloton Interactive (PTON -0.98%) shares ended 2022 down 78% as its downward spiral continued. Since the start of this year, however, the stock is up a whopping 40% (as of this writing). Maybe investor sentiment is finally turning positive on this troubled business?

Not so fast. The most astute investors are aware of a major issue with this former Wall Street darling. Here's what you need to know about Peloton as we look toward the rest of 2023. It will likely leave you hesitant to be a buyer of the stock right now. 

Peloton has an inventory problem 

Peloton's sales and subscriber numbers surged as a result of the coronavirus pandemic, when working out at home was the de facto choice for most consumers. But as the pandemic's influence has waned, the business has reported three straight quarters of year-over-year revenue declines greater than 20%, the most recent being the fiscal 2023 first quarter (ended Sept. 30).

It will only get worse. The management team, led by CEO Barry McCarthy, expects fiscal second quarter revenue to show a 37% drop from the prior-year period, while the base of connected fitness subscribers rises just 8%. 

Forecasting pandemic-fueled demand to persist indefinitely was the previous leadership team's biggest mistake. This resulted in a hardware inventory glut. As of Sept. 30, Peloton had $993 million of inventory on its balance sheet, its largest asset category. This consists of apparel, accessories, and exercise equipment that are all depreciating with each passing day.

In fact, Peloton writes down a portion of its inventory balance each quarter, merchandise that it doesn't think it will be able to sell at a specific price -- or ever. In the latest fiscal quarter, the balance in inventory reserves totaled $280 million. Management broke down that figure in its quarterly filing:

The Company recorded inventory reserves as of September 30, 2022 primarily in the amounts of $124.9 million related to excess accessories and apparel inventory that the Company does not expect to sell above its current carrying value, $88.3 million related primarily to returned Connected Fitness Products that the Company does not expect to sell, and $41.9 million in reserves for component parts that the Company estimated would have no future use.

High interest rates, elevated inflation, and general macro uncertainty are seriously hurting Peloton. People just don't want to fork over a four-figure sum for a Bike, Tread, or Row in this type of economic environment. This means that even though management believes the inventory balance will decline throughout the rest of fiscal 2023, it will still likely remain elevated when compared to overall assets.

This is bad, not only because it ties up cash, but because it increases the chances that these products will become obsolete over time as Peloton introduces newer versions of its connected fitness lineup. Going forward, a more cautious approach is necessary.

It's best to avoid the stock 

Unless revenue and the connected-fitness subscriber base start to grow quickly again, I see no reason why investors should take on the risk that comes with buying this stock. Sure, Peloton shares currently trade at a price-to-sales multiple of just over 1.0, far lower than the historical average of 6.3. But there is just too much uncertainty in Peloton's outlook.

"I was just going to say that we have seen some research that indicates that the economy is a headwind for us as it is for many other companies," CFO Liz Coddington said on the fiscal first-quarter earnings call. "And that is currently having an impact on near-term connected fitness hardware demand."

Because they stopped providing full-year guidance, even the management team tacitly admits they really don't have much visibility into the at-home fitness market this year. If they can't predict when things will improve, how can an individual investor with far less information have any idea? 

If at some future point, Peloton can right-size its operations by boosting demand and lowering its net losses, then it might warrant a closer look. For now, however, it's best to pass on the stock.