Fitbit (NYSE: FIT) shares enjoyed a nice jump this week, with the stock gaining 7% in a single day. The bounce coincided with news that its activity-tracking software was one of the most downloaded apps on iTunes over the Christmas holiday.
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After a brutal 75% decline for the stock in 2016, any evidence that hints at a brighter picture for Fitbit device sales could send shares spiking. However, that's no reason to rush out and buy the stock in hopes of benefiting from a sharp demand uptick.
A holiday-quarter surprise
Other data points imply a less-than-stellar outing for Fitbit and its activity trackers this holiday season. Retailer checks by a Wall Street analyst at Pacific Crest, for example, found elevated inventory levels that implied the Charge 2 and Flex 2 devices weren't moving as fast as expected.
Image source: Fitbit.
The research jibes with management's own reading. In early November, Fitbit executives said they were seeing softness in overall demand relative to their prior targets. "We expected higher sales growth based upon a robust product portfolio," Chief Financial Officer Bill Zerella told investors after the company sliced its full-year revenue and profit targets.
Even if Fitbit manages surprisingly strong sales volumes this quarter, the gains could come at the expense of falling average selling prices and perhaps a further decline in gross profit margin. In other words, shares could suffer even if the company beats its own bleak guidance targeting as much as $750 million of sales in the fourth quarter.
Fitbit's stock pops higher from time to time in response to rumors that it will be acquired. The idea is appealing. After all, the company is the market share leader in the high-growth wearable tech industry. It would make an easy acquisition for many tech companies, too, especially given that it recently drifted below $2 billion in market capitalization from almost $7 billion at the start of 2016.
Image source: Getty Images.
It's never a good idea to make a potential buyout your core investing thesis, though. Acquisition rumors come and go, and in some cases are completely fabricated. Operating trends are far more important to long-term shareholder returns. And right now, those trends suggest Fitbit has a dominant hold on its industry, but is also likely to see intense pressure on its earnings power over the short term as sales growth decelerates and it ramps up product development spending.
It's on sale
Shares are down more than 70% over the last year, meaning investors can grab this stock for less than $8 per share even though it was pushing $30 as recently as January 2016. The same trend holds for its price-to-earnings ratio, which passed 30 at a few points over the last 12 months but is now stuck at an all-time low of 16.
Yet investors purchasing shares a year ago were buying a business that was growing at a 92% pace and enjoying expanding profitability in a surging industry. Today, Fitbit is forecasting just 2% sales gains for the fourth quarter and has seen its gross profit margin drop to 45% of sales from 48%. Not only has the market matured into slower overall growth, but rivals at every price point are stepping up their games. Garmin (NASDAQ: GRMN) poured resources into product development over the past year and it just recently boosted its advertising spending plans to support its newest crop of wearables. These moves have sparked a nice rebound in Garment's sales growth. Its fitness device segment grew 32% in the third quarter, up sharply from a 9% pace to start the year.
Fitbit is aiming for a similar recovery by plowing cash into research and development and marketing. Until there's real evidence of that rebound, though, the stock isn't likely to claw back a significant portion of its 2016 losses.
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Demitrios Kalogeropoulos has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Fitbit. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.