Please ensure Javascript is enabled for purposes of website accessibility

Why Fitbit Inc. Stock Fell 27% in August

By Asit Sharma - Sep 11, 2015 at 3:00PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The maker of popular fitness devices couldn't seem to please investors despite monster revenue growth in its first reported quarter as a public company.

"Fitbit at Mobile World Congress 2015 Barcelona" image by Karlis Dambrans under Creative Commons license.

What: Shares of Fitbit (FIT) fell 27.5% during the month of August, according to S&P Capital I.Q. data.

So what: Fitbit sank 13.6% after reporting second-quarter 2015 earnings on August 5, and never really recovered as the month wore on. While the company delivered truly impressive revenue growth, investors appeared to be worried over a deterioration in gross margin.

Fitbit improved its revenue by roughly 250%, selling $400.4 million of product versus $113.6 million in the prior-year quarter. However, as several analysts pointed out immediately after the earnings report, the company's gross margin declined by 5 percentage points versus the prior year, from 52% to 47%.

The shrinking in gross margin was accompanied by a surge in research and development spending, which more than quadrupled to $70 million in comparison to Q2 2014.

As a result, despite a ramp-up in revenue of more than 2.5 times against the comparable period, Fitbit's operating income of $80.4 million actually decreased, as a percentage of sales, by 2.7%. 

Now what: Why would a 5% drop in gross margin so worry investors that they'd punish the stock in dramatic fashion? Gross margin is derived from sales less product costs, and a good portion of these costs are usually thought to be somewhat controllable by management as opposed to, say, fixed non-production expenses (for example, administrative payroll).

As a company scales its revenue, gross margin theoretically should hold even, and in many cases, improve, as the organization sells more and more goods beyond its breakeven point in a given quarter.

Thus, it can often come as a shock when revenues have improved dramatically but profits actually deteriorate. But in this case, investors may have overreacted just a bit. It's one thing for a young company selling into market demand to bump revenues by, say, 20% or 30%. But at a sales leap of 250%, it's likely that Fitbit was attempting to meet every last bit of demand possible. The company sold a cool 4.5 million devices during the quarter.

With such explosive growth, production and the supply chains that make production possible are often works in progress and not configured for maximum efficiency. Management is projecting that gross margin will remain in the current range of 47%-48% for the rest of the year. It's likely that investments being made in 2015 will lay the groundwork for improved margin next year as Fitbit adjusts its capacity to meet global consumer thirst for its wildly popular devices.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Fitbit, Inc. Stock Quote
Fitbit, Inc.
FIT

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
328%
 
S&P 500 Returns
116%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/19/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.