I don't mean to denigrate the hard work and accomplishments of the people at GoPro (NASDAQ:GPRO), but it's important for investors to realize that its shares shouldn't be valued as if the company invented the next big thing in consumer electronics.
GoPro's stock is up almost 150% since the company went public earlier this year, and it currently trades for more than 200 times earnings. That means GoPro's net income would have to quadruple, and sustainably so, before its valuation equals that of the broader market.
Lacking a durable competitive advantage
"GoPro is transforming the way consumers capture, manage, share, and enjoy meaningful life experiences," the company said in its latest quarterly report. "We do this by enabling people to capture compelling, immersive photo and video content of themselves participating in their favorite activities."
What GoPro means is that it pioneered, and has since refined, a line of digital cameras designed for people to mount on the end of a surfboard, the top of a helmet, or on the handlebar of a bicycle, among other places.
It was a great idea. And it has led to remarkable footage over the years. But manufacturing digital cameras ultimately does not lend to what Warren Buffett calls a durable competitive advantage:
The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.
I'm far from the first person to make this argument. As my colleague Keith Noonan recently wrote, "an influx of competitors threatens to erode GoPro's mind and market share advantages, [a]s companies like Sony and HTC look to carve out bigger shares in action cameras."
Moreover, according to the collective judgment of investors on The Motley Fool's CAPS service, which allows members to rate stocks based on future potential, GoPro's outlook is "ominous." It garners a rating of only one out of five stars.
The odds are stacked against GoPro
I'm not necessarily asserting that GoPro won't generate market-beating returns for its shareholders over the long run. I am saying, however, that without a durable competitive advantage it won't be able to do so unless it fundamentally transforms its business model.
Amazon.com started as on online bookseller, but look at it today. IBM emerged from a consolidation of companies that sold antiquated tabulating devices, but is now an industry-leading consulting company. CarMax's origins trace back to a skunkworks project at, of all places, the now-defunct electronics retailer Circuit City.
In other words, a bet on the long-run success of GoPro is not a bet on digital cameras; it is instead a bet on the company's ability to use them as a springboard into business lines that will better shield it from competitors. Even more specifically, per Jim Collins' book Good to Great: Why Some Companies Make the Leap ... and Others Don't, it's a bet on the ability of GoPro's managers to stay humble, committed, and always willing to subjugate their own interests to those of the company, as these are the qualities that allow businesses to make the transition called for in GoPro's case.
While the failure of GoPro might ride on digital cameras, its success will be powered by the qualities of its leaders. Consequently, if you're a current or prospective investor in the company, you'd be wise to largely ignore analysts' obsession with GoPro's quarterly sales figures in favor of a thorough assessment of its executives.