Why Fitbit Shares Plunged Today

What happened

Shares of Fitbit (NYSE: FIT) have plunged today, down by 10% as of 2:40 p.m. EDT, after Morgan Stanley downgraded the stock to underweight, or the equivalent of a sell rating. Analyst Yuuji Anderson also reduced the firm's price target on Fitbit from $5 to $4.

So what

Anderson is concerned that demand for Fitbit products may never recover, as the wearables market is rapidly shifting away from "legacy products" like basic fitness trackers toward smartwatches. If revenue fails to stabilize, Fitbit's cash burn may exacerbate. Revenue fell 25% in 2017 and the company burned $25 million in free cash flow during the year.

In Anderson's view, Fitbit's smartwatches are unlikely to offset the loss of revenue from legacy products.

Now what

The company released the Versa last month, a "mass-appeal" smartwatch priced at $200, after the Ionic fared poorly over the holiday shopping season.

While Fitbit does have some opportunities in building a digital health platform that features personalized health coaching, those efforts "will take time to ramp," according to Anderson. In the meantime, Fitbit's financials could continue to deteriorate if "demand for new products does not rebound meaningfully." The analyst is even modeling for a bear-case scenario where demand falls even faster, with a price target in that scenario of $2.

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Evan Niu, CFA has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Fitbit. The Motley Fool has a disclosure policy.