Since its initial public offering, shares of GoPro (NASDAQ:GPRO) -- a well-known supplier of wearable cameras -- have been on a massive run. The shares are now up a whopping 69% from their initial offering price of $24. Although the company makes a product that many people seem to like, and although its growth so far has been strong, is the stock simply running too hot?
What does $5 billion buy you?
At the most recent close of $40.65 per share, GoPro is valued at just a dash under $5 billion. According to GoPro's S-1 filing, the company generated $986 million in sales and from that about $60.6 million in net profit in 2013, meaning that the shares now trade at about 82.5 times 2013 net income.
Now, GoPro is also a very high growth company, so the expectation is that this ratio will come down pretty significantly in the coming years. Indeed, in 2010, the company generated just $64.4 million in sales (and generated $11.58 million in net income), but that number grew substantially over the subsequent years.
Can this growth continue?
Keep in mind though that this growth is bound to slow simply by virtue of the fact that the total addressable market is finite. Further, given GoPro's massive financial success, it is likely that others will try to muscle in on that opportunity.
That being said, GoPro does have an uncommonly strong brand driven by very innovative marketing. For example, its "Be a Hero" series of ads in which the company shows various (often touching) use cases for the GoPro cameras likely leave a lasting impression on consumers. Further, the product that GoPro offers -- though likely not offering substantial barriers to entry -- is known to be of good quality.
So, the questions that investors really need to ask themselves are:
- How large is the market for wearable cameras likely to be, and what percentage of that market can GoPro capture over the long-haul?
- GoPro's gross margin profile sits at a rather lofty 36% for a product with a relatively low barrier to entry. Can this gross margin profile be maintained as competitors gear up their efforts?
With those questions in mind, let's see if we can find a way to justify the current share price.
What does it take to justify a $5 billion market capitalization?
Over the long run, a company like GoPro that focuses exclusively on the sale of consumer-oriented cameras, is unlikely to command a rich multiple once the growth slows to a mid- to high-single digit rate. So, assuming that over the long-haul, GoPro will trade at about 15 times trailing earnings, what kind of earnings power is the market assuming?
At $5 billion, GoPro would need to generate $333 million in net income, or roughly five times what the company was able to generate in 2013. If we assume that GoPro can keep its gross margin profile at about 36% and that it can keep operating expenses roughly flat from current levels, then GoPro would need to do about $1.66 billion in sales -- a 68% increase from current levels.
Foolish bottom line
The valuation, though certainly on the rich side, seems to bake in expectations that the company's gross margin profile stays roughly flat, its operating expenses stay flattish, and sales grow by another 68%. While this isn't unrealistic given the historical growth rates of the company, the questions of just how large the total market is likely to settle at and what percentage of that market GoPro can ultimately take are still open.
Is GoPro necessarily overvalued relative to its long-term prospects? No, but there's definitely a lot of optimism here that has sucked out a good portion of the potential upside for investors getting in today. Further, the risks here -- which include eventual margin compression -- are nontrivial. While GoPro may be an appropriate pick for investors with high risk tolerance, more conservative investors should probably stay on the sidelines for now.