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GoPro Inc. Stock Is Down a Lot and I'm Pretty Excited

By James Sullivan - Sep 16, 2015 at 9:00PM

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The future is bright because of GoPro's profitability, valuation, and balance sheet.

Source: GoPro.

GoPro (GPRO 4.64%) is a company that I had initially overlooked after its IPO. I considered it to be a fad technology company that produced a premium product, but didn't have any real staying power. I was afraid that hardware margins would be beaten down as action-sports cameras became commoditized.

During the next few months, I began to follow the company more closely, and made a few small purchases at prices significantly higher than where the stock trades today. I was impressed with founder/CEO Nick Woodman, the overall quality of the cameras, and most recently, the company's efforts to build a media company and a lifestyle brand.

There's still more risk in GoPro than in stable, mature companies, but the stock's recent tumble has made it extremely compelling. I really liked it at $60, and I love it in the low $30s. Here's why.

1. It's really profitable
I find that investors will often build in mental shortcuts when thinking about stocks. A packaged-goods company is safe and probably cheap, even though it might trade at a multiple dear to the overall stock market.

Energy companies are safe dividend payers, right up until oil prices plummet, and they're forced to suspend payouts. In the case of GoPro, the saying is: "Young tech companies aren't profitable. They are bets on the future, but not the business of today." 

Every stock must be assessed on its own merits. When we actually look at GoPro and take away the "tech veneer," it looks like it could be a very solid company in many other industries. In 2011, years before its IPO, it earned $25 million on sales of $234 million.

These figures have improved every year since, and on a trailing-12-month basis, the company has earned $189 million on sales of just less than $1.7 billionGoPro's net margin is currently more than 10%, and its return on assets and return on equity are both excellent, at 22.9% and 41.47%, respectively.

2. Valuation is very compelling
Earnings are only one part of an investment decision. What you pay for those future earnings will determine your long-term returns. I was bullish enough about GoPro's growth prospects to pay multiples significantly higher than where it stands today. A current trailing P/E of 29 for a company with so much potential ahead of it seems more than fair to me.

However, as investors, we must be forward-looking, and this is where the investment gets even more exciting. Based on fiscal year 2016 earnings estimates, the forward P/E is below 16. This is what happens when a company continues to grow net income, and the market nonetheless beats down its share price. This P/E ratio assumes that its margins are unsustainable, and that it won't continue to grow at nearly the same pace that it has been. I disagree with both of these assessments. 

Its valuation is further reflected in its PEG ratio, which is price/earnings to growth. Companies with higher P/E ratios need higher growth rates to justify their premium valuations. A company with a P/E of 100 might be a perfectly sound investment if it is growing net income 100% every year.

Similarly, a company with a P/E ratio of 25 may be very expensive if it's merely growing along with the overall economy. GoPro's PEG is 0.59, which points to it being a cheap stock. This assumes that net income doesn't collapse in the coming years, but I think at these levels, the risk/reward profile greatly favors the long-term investor. 

3. Pristine balance sheet and optionality 
Another benefit of being profitable so early on is that GoPro has a beautiful balance sheet. With a market cap around $4.5 billion, the company has more than $500 million in cash, and zero debt. I believe that this will be fundamentally important to the future of the company. Management has already invested in initiatives to make GoPro more than a hardware company by creating a licensing portal and a very popular YouTube channel.

If management were scrambling to service debt, or constantly facing liquidity crunches, the long term would be nearly impossible to focus on. Having a net cash position of more than 10% of its market cap allows for the optionality that may make this company a huge long-term winner. This will not become a $50 billion or $100 billion company just by selling adventure cameras to enthusiasts, but I think it may get there one day by adapting its business.

I'm banking on the vision of Woodman and his team to make the investments necessary to get there. GoPro remains on the riskier side of the investments in my portfolio, but at these levels, the risk is mitigated greatly. If you haven't considered GoPro and are looking to take advantage of a big drop, I recommend you take a deeper look.

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