Fitbit (FIT) jumped 50% on its IPO and has climbed to over $35 as of the time of writing, with today its first decline after the stock began trading. Many retail investors are jumping into this stock based on a feeling, or a sense that wearables are the next big high growth market, and this is an opportunity to get in on the ground floor.
Professional investors need to be more disciplined. For them, whether or not to buy FIT depends entirely on the company’s financials. More specifically, professionals need to ask themselves a few questions, some quantitative and some qualitative:
- What is FIT’s total addressable market (TAM)?
- Who are its competitors?
- What are regulatory and market risks to the company’s business model?
- How fast is its revenue growing and projected to grow?
- Is it profitable? Will it be profitable in the future? How long can it remain profitable?
- At current prices, how much does it cost relative to revenue and earnings?
Some of these questions are very easy to answer, and they can all be answered by a quick study of the company on SEC’s Edgar service and through Google Finance, Yahoo Finance, or a similar site. In other words, all the information is already out there—it’s just up to you to find it.
Revenue and Earnings
The company earned $745 million in revenues last year, up 174% from the prior year. How do I know? Because Edgar tells me:
On top of that, the company’s top line growth rate for the first quarter of 2015 was 209% compared to the prior year, indicating that growth isn’t just maintaining itself—it’s accelerating.
The company is also profitable. With $158m in operating income and $131.7m in net income, the company has a profit margin of 17.7%—and that is likely to rise in the future since the company’s research and development expenditure is quite high, which is common for an early company.
The Cost of Revenue and Earnings
On paper, a fast-growing company with a strong profit margin that’s set to grow as research expenditure shrinks is a great buy—but are we too late? Does the market already recognize how great of a buy the company is based on these metrics, and has thus priced it to a fairer value?
The first metric we should look at is price to sales, which is easy enough to figure out. At a 209% growth rate in Q1, if we project a growth rate of about 150%, which is assuming conservative fall in revenue growth throughout the year, we would expect FIT to make $1.1 billion this year. At a market cap of 7.36b, we’re paying over 7x forward revenue expectations. That’s expensive (for instance, NFLX is selling for 6.1x forward revenue expectations, making it 16.4% cheaper than FIT with a more established product).
The P/E ratio is much more favorable for FIT. It’s difficult to project what the P/E ratio for FIT will be, but we know its TTM P/E ratio is 92 cents, making its current P/E ratio 38. That is very low, especially for a tech company, but some would argue against that number, and others would insist that it’s impossible to determine the company’s P/E ratio yet, because with its new capital it is going to change its business model in ways that will affect its earnings in the short term.
The Qualitative Questions
This analysis gives us an idea of where the company stands financially, but it isn’t enough to make an investment decision. We haven’t even come close to the first 4 questions we posted above—but they are really the most important considerations. Financials are healthy—that just tells us the underwriters did a good job. But what about the future of wearable computing, and FIT’s place in that future? That’s the much more important question analysts need to grapple with before buying or selling this stock.