Two words can sum up the experience of Peloton Interactive (PTON 1.11%) shares since the company went public in late 2019: extreme volatility. During 2020 and early 2021, the stock soared over 400% to $150 as it became one of the "pandemic favorites" that every investor wanted. Now in early 2023, with the founder out, declining profit margins, and a stagnating user base, shares of the stock have plummeted to below $10. 

Down 95% from all-time highs, is Peloton stock officially a bargain? Or is this a value trap?

Weak growth, improving margins

The headline numbers in Peloton's latest quarterly earnings look meager. Revenue declined 22% year over year to $749 million, active members were flat from last quarter, and total paying subscribers were only up 2% quarter over quarter to 3.1 million. Net income loss was $276 million just in the quarter, for a margin of negative 37%.

While this might immediately turn away some investors, these numbers are actually much better than a year ago. In the first calendar quarter of 2022, Peloton posted a net loss of $757 million after overbuilding capacity and building way more fitness equipment than there was customer demand at the time. This was the catalyst for the board of directors replacing Peloton's founder John Foley with Barry McCarthy, a finance veteran and former leader at Spotify and Netflix

McCarthy's starting position with Peloton was dire, but he has done a great job turning around its financials. Gross profit was up 47% year over year in the quarter to $270 million, which really helped the company reduce its net loss. More importantly, Peloton has greatly reduced its cash burn, with its cash balance actually up quarter over quarter. This will give McCarthy and his team much more breathing room as they work to get Peloton back to growing revenue and positive profits.

Will the relaunch of the brand work?

New CEO McCarthy has made some large strides in fixing Peloton's business, but he still thinks the company needs to work aggressively in order to make this a sustainable business model. It has seen success with new rentals and used bike programs, which accounted for 24% of hardware sales last quarter and are growing rapidly. Getting Peloton products into as many people's hands as possible is important, as it drives more sign-ups to high-margin Peloton subscriptions, which is where the company makes all its gross profit.

Later this year, Peloton is going to launch a marketing rebrand to try to further expand its customer base. People generally think of the company as a stationary bike brand, but -- according to McCarthy -- 57% of Peloton workouts are not cycling-related and a full 38% require no hardware at all. McCarthy believes the company can attract a wider customer base by positing Peloton as more than just stationary cycling and focusing on the comprehensive workout programs found on the Peloton App.

I think this marketing change could be promising, but it doesn't change the fact that Peloton is still in a precarious spot financially. Investors should track progress from this brand revamp over the next few quarters and see if it starts producing real changes within Peloton's income statement.

What about the valuation?

Close to an all-time low, Peloton stock now trades at a market capitalization of $2.7 billion. Over the last 12 months, it has generated $693 million in gross profit and $2.3 billion in net losses. If gross profit keeps growing at a solid double-digit rate, this could indicate that Peloton stock is currently being undervalued by the market. It only trades at a price-to-gross profit of 3.8 (the average stock in the market trades around 6 to 8 times its trailing gross profit).

Chart showing Peloton's gross and net income down since 2021.

PTON Gross Profit (TTM) data by YCharts

But there is a clear reason why Peloton stock is potentially undervalued when it comes to a multiple of gross profit, and that is the billions of dollars it has lost over the past year. No matter how optimistic management sounds about new initiatives and a brand rebuild, Peloton is still losing money every quarter and won't be a strong-performing stock until that changes.

Unless you are confident that McCarthy's strategy will lead to positive profit margins, it is probably best to avoid buying shares of Peloton, even at close to an all-time low.