GoPro's (NASDAQ:GPRO) stock has slumped nearly 23% since Oct. 7, after a double whammy of bad PR regarding Michael Schumacher's skiing accident and a weak market ended its meteoric gains over the past four months. But since this high-flying stock is still up 236% from its IPO price of $24, investors are probably wondering if this pullback is a buying opportunity or a bull trap. Let's take a look at three things to consider before investing in GoPro.

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Source: GoPro.

Valuation and fundamentals matter
At $80 per share, GoPro trades at a whopping 255 times trailing earnings and 76 times forward earnings. That bubbly valuation makes it a "cool kid" momentum stock, which is often the first to fall in a market pullback.

GoPro faces the classic problem that numerous fast-growing companies face: Its revenue growth is impressive, but it can't seem to squeeze out a profit under a pile of rising expenses. The company's revenue rose 38.1% year over year to $244.6 million last quarter, but its net loss nearly quadrupled to $19.8 million. The culprit is simple: operating expenses soared 90% to $119.5 million as it spent more on product development, marketing, and new hires.

High multiples and wobbly fundamentals will likely cause the stock to be traded on headlines, rather than financial growth. For example, one negative story about GoPro being linked to Michael Schumacher's brain injury (which the journalist later retracted as his "opinion") caused shares to plunge as much as 16% in a single day. Considering that short interest in GoPro has already risen 57% between mid-July and the end of September, we could see similar "hit pieces" which could sink the stock.

Cheaper challengers and disruptive technology
GoPro controls nearly half of the action camera market, according to research firm IDC. However, the rest of the market is fragmented among competitors all focused on undercutting GoPro's premium price tag.

Over the past several months, Polaroid, Kodak, HTC, and other competitors unveiled cheaper action cameras which match or surpass GoPro's specs for $100 to $200. That rising competition forced GoPro to launch its entry level HERO, a $129 camera, which records 1080p wide angle video at 30 fps, at the end of September.

However, launching a low-end device could cannibalize sales of higher-end products like the $499 HERO4 Black and the $399 HERO4 Silver. The Black can capture 4K video at 30 fps, but it could be unnecessary unless you own a 4K TV. Launching a low-end device could also cause margins to contract and lead to even wider losses ahead.

Meanwhile, GoPro's success has fueled a creative explosion of new form factors for action cameras. HTC uses a periscope design for its new RE Camera, Polaroid has been experimenting with tubular designs, and Casio has developed a convertible device that consists of an action camera that can be detached from a regular camera.

Several other companies -- including Kodak, VSN Mobil, and VOXX International (NASDAQ:VOXX) -- are even developing 360-degree action cameras which can be mounted onto GoPro's mounts. Some of these devices will likely miss the mark, but these new designs could make GoPro's cameras look and feel dull.

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L to R: HTC's RE Camera, Kodak's SP360, and Casio's EXILIM EX-FR10.

Unclear plans for the future
GoPro's plans for the future remain cloudy. It still hasn't secured a manufacturing contract with Foxconn, which owns 8.88% of its shares. A partnership with Foxconn could expand GoPro cameras into more markets and boost margins with lower manufacturing costs. Instead, GoPro has signed deals with smaller Taiwanese contract manufacturers, like Chicony Electronics.

GoPro has also repeatedly emphasized the growth potential of its own media network, which is currently featured on Google's YouTube, Microsoft's Xbox Live, and Virgin America's in-flight videos. While these efforts are well-placed promotions for GoPro's cameras, they don't generate any meaningful revenue yet. YouTube analytics site Social Blade estimates that GoPro's YouTube channel, which has 2.4 million subscribers, only generates $218,500 to $1.7 million in annual revenue -- not much compared to GoPro's revenue of $986 million in fiscal 2013. However, investors shouldn't completely dismiss the GoPro Network yet, since it could reduce marketing expenses with viral videos.

The Foolish takeaway
Looking ahead, GoPro shareholders can likely expect more volatility when the company reports its third quarter earnings on Oct. 30.

Investors who believe that GoPro's brand is strong enough to stave off cheaper competitors and disruptive new technologies should consider entering a position. However, investors should also remember that at its current valuations, GoPro needs to deliver a nearly flawless earnings report and rosy forward guidance to keep its four month rally alive.

 

Leo Sun has no position in any stocks mentioned. The Motley Fool recommends GoPro. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.