I'm mostly a dividend focused investor. However, in the spirit of the great Peter Lynch's philosophy of "buy what you know" I recently opened a small position in Fitbit (FIT +0.00%) because not only do I love the products, but I believe Wall Street has overreacted by beating down shares to an all time low.
Strong, expectation beating growth potential could last several more years
Sources: Company Earnings Presentation, author's chart
Not only has Fitbit managed impressive growth over the past two years, but more importantly its introduction of new, higher priced and feature-rich models, such as the Charge HR and Surge, have resulted in impressive growth in the average selling price or ASP of its fitness trackers.
In Q3 2015 the company's three most expensive products accounted for 79% of sales, demonstrating Fitbit's devices have found traction with consumers looking for more premium products.
With the recently introduced Blaze coming in at $200, halfway between the Charge HR and Surge, Fitbit could see its ASP rise even further in 2016 if the new product is a hit.
Another reason to be bullish about Fitbit's short-term to medium-term growth prospects is the fact that through Q3 of 2015, the company was only selling its fitness trackers in 48,000 retail outlets in 55 countries.
Fitbit continues to expand globally and increase its sales channel, especially in India and China, where the company just began selling products.
The aggressive global rollout has resulted in the company's year-over-year European, Latin American, and Asia-Pacific sales growing by 282%, 286%, and 314%, respectively, in Q3 of 2015. Granted Fitbit's revenues are still dominated by the US which make up 66% of sales versus Asia's, Europe's, and Latin America's 6%, respectively.
However, given that Fitbit has been successful in capturing high market share in the UK, Germany, France, and Australia, I'm reasonably confident that continued global expansion is likely to lead to revenue and earnings growth far in excess of analysts' respective, 33% and 12% sales projections for 2016.
Strong balance sheet means strong competitive position from which to innovate
| Metric | Q3 2015 |
| Long-Term Debt | $0 |
| Cash and Cash Equivalents | $575.5 million |
| Current Ratio | 2.6 |
| YOY quarterly increase in R&D Spending | 187% |
Source: Fitbit Q3 Earnings Presentation.
As you can see Fitbit's balance sheet is rock solid, with short-term assets nearly triple its short-term liabilities, and a large cash reserve giving the company a strong financial base from which to defend its status as the king of fitness trackers. Why is this such a competitive advantage?
Simply put, in an extremely competitive industry such as fitness/health wearables, adding new features and improving old ones is the key to maintaining both market share, growing brand value, and maintaining strong pricing power.
Co-founder and CEO James Park is well aware that Fitbit must continue innovating and improving its products, which is why the company continues to make R&D a top priority. For example, in an interview with TIME, Park hinted that Fitbit is planning on integrating new sensor technology into 2016 products that allow for the monitoring of blood pressure and stress.
In addition, new health sensors are hitting the market that allow for the continuous monitoring of blood glucose levels. Fitbit could integrate these sensors into its products to help expand their potential market to tens of millions of individuals with diabetes.
However, aggressive innovation is expensive. Luckily Fitbit's cash from operations increased 37 fold year-over-year in the last quarter and helped boost the cash on its balance sheet by nine fold.
Such amazing operating cash flow growth should continue fueling Fitbit's fast growing cash position. This in turn would give the company plenty of ammunition to continue to increase R&D spending, expand globally and fund acquisitions to strengthen the brand.
In fact Fitbit recently stating that such M&A will be a "big part" of its 2016 growth strategy, which makes a strong, cash rich balance sheet essential to executing on its growth plans.
Risks to be aware of
I won't sugar coat it, Fitbit faces three potentially major risks. First, fierce competition from the likes of Jawbone, Misfit, and Under Armour (UA +3.03%) for market share of the fast growing fitness wearables market.
Under Armour may prove to be Fitbit's most formidable competitor. In 2015 it spent $560 million on its acquisitions of Endomondo and MyFitnessPal apps to strengthen its fitness ecosystem.
In addition, the launching of Under Armour's new $180 fitness band -- a direct competitor to Fitbit's popular $150 Charge Charge HR tracker -- means that Under Armour is gunning for the premium fitness wearable market that is currently dominated by Fitbit. Given Under Armour's strong brand among athletes its possible it might be able to steal substantial market share, especially if it launches additional, higher priced, feature rich trackers in the future.
The second major risk is the threat that smart watches represent, specifically the possibility that "do all products" will make fitness/health specific wearables obsolete as the smartphone did to stand alone GPS devices or digital cameras.
I admit that Fitbit's market share in the overall wearable market may decline some due to these higher priced "swiss army knife" products, but I think concerns from the Fitbit bears are overstated
This is because, unlike the obvious case for why consumers would want or need smartphones that can replace so many tech gadgets, the case for smart watches, which currently only copy smartphone features, isn't that strong.
For example, paying $300+ for smart watch that has thousands of potential apps that are less easy to use than those on one's smartphone (which many people carry with them at all times) seems like an answer to a question no one asked.
Which is why I believe that specialized health/fitness trackers that offer users a richer, more in-depth look at a growing number of important health metrics -- and at a lower price points -- will continue to do well in the years ahead.
The last major threat currently facing the company is a class action lawsuit,alleging that Fitbit's heart rate sensors are dangerously inaccurate and that management knowingly hid this from investors.
Should Fitbit lose this case not only would it be exposed to potentially large financial damages, but the proven inaccuracy of its heart rate monitoring could greatly damage its reputation and destroy its brand value.
It's worth noting Consumer Reports' recent findings that the company's heart rate tracking is highly accurate seems to give credence to Fitbit's claims that its technology is sound and this lawsuit is without merit.
Bottom line
By no means am I saying that Fitbit's risks aren't real or that its success is guaranteed. However, given the company's strengths: a potentially very long growth runway, history of innovation, and cash rich balance sheet, I believe Wall Street's overwhelming pessimism -- 75% of its float is held by short sellers -- has resulted in a share price that fails to properly account for the company's long-term growth opportunities.
