I always get a sinking feeling when a company like Fitbit Inc (NYSE:FIT) goes public. That’s because Fitbit stock screams “fad!” at me. It seems like it is some great new technology that will take over the world, but in the end, it’s really nothing more than a souped-up calorie and step counter.
Fitbit doesn’t solve a problem. Thus, it won’t be a sustainable business.
That became clear again yesterday as Fitbit earnings for the third quarter came out. That became clear again this morning as FIT stock sank 30% in response to the report.
Q3 profits were in line, and I’ll look at those numbers in a moment. But the thing that will haunt Fitbit stock was a light fourth-quarter projection.
One of the problems with products like those offered by Fitbit is that sales can seem fine, the company will set its advertising budget, and then the world throws it a curveball that it cannot recover from.
FIT says it is spending too much on marketing because it expected a certain sales level that won’t be met. In fact, earnings for Q4 are expected to be half of what was originally anticipated.
This, as I said, came as no surprise to me. The only reason I did not short Fitbit stock was because the erratic nature of a fad product could result in a big upside surprise.
So we know what Q4 will be like. However, let’s take a glance at Q3 so we can determine the exact status of the business, the balance sheet and cash flow. Sometimes even a fad stock can present a short-term value if certain elements line up.
Fitbit Earnings at a Glance
Net income fell from $45.8 million to $26.1 million, so that is almost a 45% decrease. For the YTD, net income is off almost two-thirds to $43.5 million. Total devices sold rose from 4.8 million to 5.3 million, an 11% increase.
So the problems were really on the expense side.
As mentioned, sales and marketing expenses are hurting FIT stock. YTD those rose 70% to $305 million. R&D more than doubled, up almost 150% to $235 million, and general & administrative spending more than doubled from $48 million to $106 million. Thus, the overall doubling in expenses cut operating income by two-thirds, and net income, as well.
I believe this will be an ongoing problem for Fitbit stock. FIT simply is not the kind of company that can just issue a product and let it ride. It must constantly chase its tail to improve on, again, what I believe is really a fad product.
Even worse, shareholders were badly diluted as shares outstanding rose from 137 million to a whopping 243 million.
Now, there is some good news.
Revenue increased 23% to $504 million in the quarter, and is up about 40% year-to-date.
Moreover, Fitbit at least has some padding. It has $672 million in cash and no long-term debt, or about $2.80 per share in cash. And FIT should have about $150 million in profit for FY16. At the current after-hours price of $9.03, and backing out net cash, it has a market cap of $1.4 billion, so it trades at about 10 times those earnings.
What to Do About Fitbit Stock
I definitely do not see FIT stock as a long-term hold. I think, however, there may be a short- to medium-term trade.
Fad stocks often have second pops at some point, as management either gets lucky with a run on the product or they announce some kind of turnaround that captures the market’s attention. Crocs, Inc. (NASDAQ:CROX) and Build-a-Bear Workshop, Inc. (NYSE:BBW) are examples, although those took a very long time to materialize.
I think buying Fitbit stock at $9 or under may turn out to be a decent trade, enough to squeeze out several points. You could wait for even lower prices, as I could see it getting to $6 if the market tanks post-election. You could even buy in small bites and average down.
This is, however, a speculative trade! So buyer beware.
Lawrence Meyers is the CEO of PDL Capital, and manager of the forthcoming Liberty Portfolio stock newsletter. As of this writing, he has no position in any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at [email protected].