Warren Buffett, the legendary investor who has a remarkable track record leading Berkshire Hathaway, emphasizes thinking in probabilities. There are varying degrees of certainty with each possible outcome, and this can help inform how investors allocate capital.
We can use this mental framework when looking at struggling fitness enterprise Peloton Interactive (PTON 3.01%). Shares of this consumer discretionary stock are currently 98% below their all-time high, which might entice some investors looking for potentially outsized returns if a successful turnaround happens.
As we consider where Peloton might be five years from now, let's look at what I believe are two realistic outcomes.
What the bulls want
Despite ongoing revenue declines and hundreds of millions of dollars in quarterly net losses recently, Peloton deserves credit for what it has accomplished since its founding in 2012. The business leveraged technology, digital capabilities, and the internet to build a successful connected-fitness platform that resonated with consumers. And its brand is well-known in the industry.
The bulls want Peloton to continue leaning on these strengths to get back on track. This starts with finding ways to drive demand for the company's exercise equipment and fitness app.
Chief Executive Officer Barry McCarthy is broadening Peloton's horizons by expanding distribution and signing new content partnerships. And Peloton continues focusing on what it does best -- creating compelling workout content in numerous fitness modalities.
If things start going well, Peloton's sales should exhibit growth. Add this to ongoing cost cuts and an emphasis on financial discipline that wasn't a priority during the depths of the pandemic, and this could be a profitable enterprise.
Peloton shares trade at a low price-to-sales ratio of less than 0.5. Even if the leadership team can start to register small and consistent improvements, that valuation multiple should start to trend in the right direction. And in five years' time, the stock could be a massive winner for investors.
What the bears are thinking
Going back to Buffett's focus on thinking in terms of probabilities, I give the bullish outcome a less than 10% chance of actually happening. I think there's a lot going against Peloton right now that makes the bearish scenario more probable.
Drumming up interest from consumers has been the single greatest challenge for this company. Peloton's expensive bikes and treadmills were selling like hotcakes a few years ago. When everyone was stuck at home with no other way of working out, those products practically sold themselves.
These days, I don't know if there's sustainable demand from people to want to spend four-figure sums for things they might not even use that much. Add this to an uncertain economic environment and the possibility of a recession, and it's easy to be pessimistic.
Competition is another factor that will get in Peloton's way. Other equipment makers and fitness apps are on the market, and people can always go to physical gyms. Plus, consumers can work out anywhere with just their bodies.
There's a ton of free exercise content available online, too. For Peloton to succeed in the long run, it's banking on its user base to stick to their workout routines to discourage them from canceling their subscriptions. I'm not confident making that kind of bet.
"Turnarounds seldom turn," Buffett once said. This means the struggles are likely to continue, and there's no telling when the net losses will end.
I give this bearish outcome an extremely high probability of occurring, based on the facts we have in front of us. Therefore, investors are better off avoiding this stock until there are major improvements -- namely, consistent growth and positive earnings.
