I love my Fitbit(NYSE:FIT) fitness tracker. It has gotten me off my you-know-what and kept me off it, too. The company even provides charts and weekly emails proving that, at least for me, it works. If I start slacking off, the weekly emails serve as reminders -- nudges -- to get moving.
Thinking Fitbit could be my chance to buy into high-growth investment and make some big bucks, I followed the advice, "If you love the product, check out the stock". Low awareness of the products among people I know suggests I'm an early adopter. Google Trends confirmed that suspicion: For every 57 Google searches for "iPhone" in September, there were only three searches for "Fitbit".
Fitbit revenue grew a whopping 175% in 2014 -- yes, the top line almost tripled last year -- to $745 million. The company went public in June. With that, it was time to move Fitbit stock from the investment idea stage to the investment research stage.
Leading in a rapidly growing market but still more to the story
What did I learn? Fitbit is a pure-play market leader in fitness trackers. Business Insider Intelligence expects the market for these devices to grow from 11.9 million in 2015 to 29.6 million in 2019. That is annualized growth of 20%. Keep in mind that market forecasts for immature technologies should always be viewed with a particularly skeptical eye. Growth rates typically slow as a market gets larger and matures. So, growth from 2015 to 2019 may turn out to average 20% ... or 15% ... or 30% ... or, well, you get the idea. While it's hard to predict with accuracy, growth is expected to be robust compared to most other sectors.
Then, I discovered three things Fitbit wouldn't want me, or you, to know:
- A huge portion of Fitbit owners quit using them within six months.
- Analysts don't have a good read on what Fitbit can earn.
- The stock's forward price-to-earnings ratio isn't justified by expected earnings growth.
Walking the recommended 10,000 steps a day takes roughly 90 minutes. Running 10,000 steps could cut that time by about half. Who has that kind of time, I wondered? For most people, myself included, 10,000 steps a day demands a major lifestyle revamp. That kind of change is not easy. So, I surveyed a handful of Fitbit users regarding their fitness tracking experiences. Not one of them used the Fitbit for more than six months.
And I was not the only one to come to this conclusion. According to NPD, 42% of fitness tracker owners quit using the devices within six months. While smartphone users rush to upgrade their handsets to the newest generation, the NPD findings suggest that a much smaller subset of Fitbit owners will be clamoring for the latest tracker and contributing to the top line.
Analyst estimates are even less reliable than usual
For 2016, analyst estimates for Fitbit earnings range from $0.82 to $1.16. The high estimate is 18% above the average, while the low estimate is 16% below. That huge range tells me that analysts don't really have a good idea what level of earnings the company can deliver. Perhaps that's because they don't have a good idea of how many trackers the company is likely to sell either.
Analyst estimates for 2016 full-year revenue range from $1.96 billion to $2.50 billion, again a wide range that indicates the market is uncertain whether Fitbit will be able to maintain such strong growth going forward.
Results don't support the stock price
It takes some pretty impressive earnings growth to justify Fitbit's forward valuation of nearly 35 times earnings. A common rule of thumb says that an acceptable price-to-earnings ratio is a similar number to expected earnings growth. In other words, 20% growth is justified by a 20 times valuation, 30% growth is justified by a 30 times valuation, and so on. But analysts are forecasting 2016 earnings growth of only 18% for Fitbit in 2016 on revenue growth of about 33%. And let's not forget that analysts have a history of rather optimistic forecasts that get lowered over time.
Fitbit's heady valuation suggests the stock is too expensive unless the most optimistic earnings estimates prove correct. Even then, valuations are best justified by sustained earnings growth at that elevated rate over many years, which is particularly hard to achieve, especially for a young company in an increasingly competitive space. As already noted, growth rates typically slow as a market gets larger and matures.
Sadly, it doesn't look like I have stumbled onto the next big thing.
The company's website proclaims, "Our users take 43% more steps with Fitbit." The key word here is probably "users" -- i.e., what percentage of Fitbit owners are actually users? According to NPD, it's only a little more than half. That could mean fitness trackers end up settling into a niche market if they even survive as standalone devices.
Cindy Johnson has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Apple. 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.