Investors Shouldn't Ignore Fitbit's 4 Biggest Risks

By Leo

Fitbit isn't a stock for nervous investors. In just five months, shares soared from their IPO price of $20 to over $50, then plunged back to around $30. Although Fitbit posted triple-digit revenue growth in both quarters since its IPO, some investors fear that it can't compete against low-end fitness trackers from Xiaomi and health-tracking smartwatches like the Apple Watch.

Between the second quarters of 2014 and 2015, Fitbit's worldwide market share in wearables fell from 30% to 24%, accordingto IDC. During that same period, Xiaomi and Apple's market shares rose from nothing to 17% and 20%, respectively. Fitbit's decline, along with its contracting margins, convinced many investors to sell the stock.

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Image source: Fitbit.

But to fully understand the headwinds Fitbit faces, investors should dig deeper into its SEC filings. Let's take a look at the four main risks that Fitbit discusses in last quarter's 10-Q filing, and what they mean for the company's future.

1. Profits aren't guaranteedIn the filing, Fitbit warns that its revenue growth could slow down in "future periods" due to weaker demand for its products and services, rising competition, and the slowing growth of the health tracking market.

Fitbit also warns that competition and new products could cause the average selling price of its products to decline. Fitbit says that if it's unable to offset those declines by boosting sales volume or adjusting its product mix, its operating results "may be harmed." Fitbit points out that although the company achieved profitability in 2014, it has not consistently achieved profitability on a quarterly or annual basis yet.

To stay ahead of companies like Xiaomi and Apple, Fitbit expects expenses to "increase substantially in the near term" as it boosts investments in R&D and sales and marketing. That's why Fitbit recently announced a secondary offering, which will let the company and earlier investors respectively sell 7 million and 14 million shares.

2. Limited supply chain controlFitbit admits that it has "limited control over suppliers, contract manufacturers, and logistics providers." This means that it might struggle with increasing its production volume to the point that "economies of scale" let it produce more devices at lower prices. This also means that it likely has much less clout than Xiaomi, Apple, or others to negotiate favorable bulk order component costs with suppliers.

Fitbit also warns that if there are defects caused by its contract manufacturers, the company could face "negative publicity, government investigations, and litigation." That statement can be applied to last year's recallof the Fitbit Force, which caused skin rashes in some customers and resulted in a class action lawsuit.

3. The health tracking market is "unproven"Research firm Parks Associates estimates that the fitness tracker market could nearly triple in value from $2 billion in 2014 to $5.4 billion in 2019. That might sound like a solid growth market, but Fitbit warns that the overall market is still in "the early stages of growth" and remains "new and unproven." A severe economic downturn could also cause discretionary income to plunge, greatly reducing demand for all health-tracking wearables.

Fitbit notes that its devices are mainly used to track basic activities like walking, running, and sleeping. But it admits that they still aren't "widely adopted" for more intense sports, exercises, and activities like cycling, skiing, and swimming -- where other niche devices are used instead. This is troubling, because Xiaomi's growth in basic fitness trackers and Apple's dominance of smartwatches has forced Fitbit to expand more heavily in the smaller "sports performance" category with devices like the Charge HR and Surge. Fitbit also believes that some people might refuse to use fitness trackers due to growing privacy and security concerns.

4. Foreign exchange risks33% of Fitbit's revenue came from overseas markets last quarter, up from 23% a year ago. While overseas growth fueled Fitbit's 168% year-over-year jump in revenues, its margins are being weighed down by the strong dollar.

Excluding currency impacts, Fitbit's non-GAAP gross margin would have risen 2.5 percentage points to 50.8% last quarter. That impact will likely increase as its overseas sales rise and the dollar strengthens. Fitbit also warns that as "exchange rates move unfavorably" against its overseas suppliers, they could pass additional costs onto the company, which would reduce its gross margins.

The key takeawayLooking ahead, Fitbit clearly needs to fight to retain its first-mover advantage in fitness trackers. It's unclear if Fitbit's brand is strong enough to hold that lead, but investors should fully understand these four big risks to measure the stock's downside potential.

The article Investors Shouldn't Ignore Fitbit's 4 Biggest Risks originally appeared on

Leo Sun has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Apple. 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.

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