4 Terrible Reasons to Buy Fitbit Inc. Stock

By Leo Sun Markets Fool.com

Shares of Fitbit (NYSE: FIT) were cut in half over the past 12 months due to the company's decelerating sales growth, contracting margins, and lack of a meaningful moat against rivals in the wearables market. However, that steep drop -- which caused the stock to drop nearly 70% below its IPO price of $20 -- might make Fitbit look like a tempting contrarian play.

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In a previous article, I warned that Fitbit was a bull trap which could ensnare investors who overlooked the weaknesses in its core business model. Today, I'll examine four common bullish takes on the stock -- and why they're deeply flawed.

Fitbit's Alta. Image source: Fitbit.

1. The stock looks "cheap"

At first glance, Fitbit's fundamentals look cheap. The stock trades with a P/S ratio of 0.6 and an EV/Sales ratio of 0.3 -- meaning that its market cap and enterprise value are both significantly lower than its revenue over the past 12 months.

However, analysts believe that Fitbit's revenue will fall 27% to $1.58 billion this year. If that downward trend continues, Fitbit's P/S and EV/Sales ratios will rise, making the stock more expensive even if its price stays the same. As long as Fitbit's sales are dropping year-over-year, investors probably won't buy the stock as a deep value play.

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2. Believing it's a buyout candidate

Another popular idea is that while Fitbit's low valuations might not attract investors, they could appeal to bigger companies looking to establish a market-leading position in wearables. However, investors should never buy a fundamentally shaky stock in anticipation of a buyout.

The only "real" buyout offer ever reported originated froman SEC filing last November, which claimed that a Shanghai-based company called ABM Capital wanted to buy Fitbit at $12.50 per share. However, Fitbit denied ever receiving an offer, and subsequentinvestigations couldn't locate ABM Capital -- indicating that it was a market-manipulating hoax.

Fitbit's Blaze. Image source: Fitbit.

3. The expansion of its digital ecosystem

Some Fitbit bulls believe that the expansion of its digital ecosystem will diversify its top line away from fitness trackers. Last quarter, Fitbit noted that its "active users" rose 37% annually to 23.2 million at the end of 2016 -- making it the "largest social fitness network".

Fitbit defines an active user as anyone who has "an active Fitbit Premium or FitStar subscription, who paired a tracker or Aria scale toa Fitbit account, or who logged at least 100 steps or took a weight measurement within three months of the measurement date." Fitbit Premium and Fitstar respectively cost $50 and $40 per year, but the company admits that revenue from those subscriptions accounts for less than 1% of its top line -- hardly enough to offset waning sales of its wearable devices.

Fitbit plans to build an app store ecosystem, but it's already fallen behind the tech curve. Garmin's ConnectIQ, watchOS, and Android Wear have already established app stores which greatly extend the functionality of their devices.

4. The growth of its corporate wellness programs

In late 2015, Fitbit signed a partnership with Target (NYSE: TGT)to provide fitness trackers to 335,000 employees. Like Fitbit's other "corporate wellness" partners, Target tried using Fitbit devices to improve employee health to reduce healthcare costs. Target employees either received the basic Zip for free, or purchased a pricier tracker with Target partially subsidizing the cost.

At the time, Fitbit bulls claimed that Target's bulk order could encourage other big enterprise customers to do the same -- which would offset waning consumer interest in its devices. Unfortunately, no new partners which were comparable to Target have signed similar deals since then. In its latest 10-K filing, Fitbit admits thatit generates less than 10% of its revenue from these programs -- which isthe same estimate it provided a year earlier.

The key takeaways

Looking ahead, Fitbit must spend more heavily on R&D and marketing to develop and promote new devices, but falling price expectations and market commoditization will likely hammer its margins. It will likely buy more companies to complement its recent acquisitions of Pebble's IP portfolio and high-end smartwatch start-up Vector, but those purchases could drain its cash flows and "diworsify" its core business.

Therefore, it's tough to see any reasons to consider Fitbit a good contrarian play at current prices. Investors should steer clear of this stock until the company reveals sustainable ways to grow its top line and widen its moat.

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Leo Sun has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Fitbit. The Motley Fool has a disclosure policy.