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Fitbit Inc. Stock: A Value Investor's Dream

By Tim Brugger - May 9, 2016 at 3:45PM

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The wearables king reports a strong Q1, but investors run for the hills thanks to “poor” guidance.

Market overreaction is nothing new. Every quarterly earnings season there are examples of investors and pundits who get swept up in market momentum, negative or positive. The most recent, and one of the more over-the-top examples, is Fitbit (FIT).

Following earnings on May 4, Fitbit stock began a rapid descent in after-hours trading that didn't stop until it had lost nearly 19% of its value. Announcing a bad quarter can do that, so Fitbit's freefall wouldn't come as a surprise if that had been the case. However, not only did Fitbit nail Q1 – as measured by its comparables and pundits' estimates -- it also raised guidance for 2016.

So what put Fitbit investors on edge? Co-founder and CEO James Park's decision to invest in new, innovative products in Q2 that in the near term will negatively affect earnings per share. That was all naysayers needed to start a Fitbit fire sale, which should be music to the ears of value investors.

Image source: Fitbit.

Just the facts
Fitbit kicked off 2016 with $505.4 million in revenue, a whopping 50% jump over a year ago. Because of a significant increase in expenses compared with 2015, research and development alone more than tripled this past quarter, from $22.4 million to $72.25 million, while EPS took a hit, coming in at $0.10 a share on a non-GAAP basis excluding one-time items, compared with $0.27 in 2015's Q1.

But analysts had taken Fitbit's increased spending into account, forecasting a mere $0.02 non-GAAP EPS. Fitbit also blew past revenue expectations of just $443.3 million, and its 4.8 million units sold last quarter was over 20% more than last year. Apple (AAPL -1.80%) doesn't release official sales figures for its much-ballyhooed Watch, but if year-end 2015 estimates from IDC are close, Fitbit is in a wearables league all its own.

Fitbit sold 8.1 million units during the recent holiday season, compared with 4.1 million Apple Watches, according to third-party estimates. No other manufacturer was even close, and based on Fitbit's strong start to 2016, there's no reason to think it will relinquish its crown as the king of wearables.

So, what caused so much investor angst? Park's guidance of $0.08 to $0.11 EPS expected this quarter was well below estimates of $0.26 a share. That was all the Street needed to begin its assault on Fitbit stock, even though Q2 revenue of between $565 million to $585 million is above the $531.3 million forecasted.

Things really take a turn toward the bizarre when Fitbit's full-year guidance is taken into account. Park increased both sales and non-GAAP EPS expectations for 2016, to between $2.5 billion and $2.6 billion in revenue and net income of $1.12 to $1.24 a share, both above vaunted analyst estimates. But nearsighted investors seemed to tune out after hearing Q2's forecast, and the Fitbit sell-off began.

A few more considerations
A closer look at last quarter should be all investors need to give Park the leeway to continue spending on innovative new products. Two of Fitbit's newest devices -- Blaze and Alta -- generated an astounding 47% of its revenue in Q1. A cool million each of Fitbit's latest Blaze and Alta devices were sold last quarter, and the latter didn't even become available for pre-order until February of this year.

Those kind of sales results should give investors confidence that when Park and team focus time and overhead on the development of new products -- which is the "problem" with Q2's guidance -- Fitbit's investments in itself pay off.

Another intriguing item Fitbit mentioned was that in Q1, 40% of the consumers who bought either a Blaze or Alta device were former Fitbit customers. That's a great sign that Fitbit is developing brand loyalty among the world's health-conscious consumers. Fitbit may not match Apple in terms of loyal customers -- no company does -- but that's an awfully good start.

For all the aforementioned reasons, and the fact that it's trading at just 9 times future earnings, Fitbit warrants a top spot on any long-term value investor's list of stocks to watch.


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