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This Fitbit Inc Stock Rally Is About to Hit a Wall Called ‘Reality’

Luke Lango

In early May, I bought shares of Fitbit Inc (NYSE:FIT) before the company’s first quarter earnings report. I reasoned that newly launched Versa smartwatch demand would boost the wearable maker’s results, and that bullish talk regarding Versa and enterprise data partnerships would spark a post-earnings rally in Fitbit stock.

Sometimes in the stock market, you’re right for the wrong reasons, and that is perfectly okay.

That didn’t happen. Instead, Fitbit stock dropped after the Q1 report, despite strong numbers, due to a weak guide which called for persistent revenue declines and margin compression.

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Fitbit stock dropped to $4.80.

Since then, though, the stock has taken off like a rocket ship. It now trades at $7.80, up more than 60% from its post-earnings low.

Why? Robust Versa smartwatch demand. And momentum in the company’s data-driven, enterprise business.

As it turns out, my call for a bump in Fitbit was a bit early. But the catalysts emerged shortly thereafter, and now, Fitbit stock is popping more than I ever imagined it would.

The question thus becomes: now what?

Time to sell. Fitbit just isn’t worth $8 today considering the competitive dynamics in the wearables market, and Fitbit’s present standing in that market.

Here’s a deeper look.

The Bull Thesis

The bull thesis on Fitbit stock is predicated largely on two things:

A turnaround in wearables market share losses powered by a pivot into smartwatches Robust growth through data partnerships with big tech companies and healthcare and insurance providers

These two catalysts have merit.

The Versa smartwatch is Fitbit’s best product ever. It took Versa only seven weeks to hit a million device shipments, which is a Fitbit product record. Versa is also the right product (a smartwatch) at the right time (when smartwatches are eating basic activity trackers’ lunch).

As such, Fitbit’s multi-year run of huge market share erosion in the wearables space may finally be nearing a close, and growth may come back into the picture.

That hardware growth should also be accompanied by higher margin software growth. Fitbit has roughly 1,500 enterprise clients, and is aggressively pushing data partnerships with big tech companies and healthcare and insurance providers. Again, this is the right move (data sharing) in the right space (smart healthcare and insurance).

Considering data is the new currency, and that Fitbit has a ton of data, monetization through data partnerships seems like a likely positive outcome for Fitbit over the next several years.

The Bear Thesis

The bull thesis, however, should be taken in context.

Apple Inc (NASDAQ:AAPL) still dominates the wearables market with more than a 16% market share. Meanwhile, Fitbit’s market share has gone from over 30% three years ago to under 10% today.

Granted, the Versa smartwatch should help ease this market share erosion. But the smartwatch space is crowded. And everyone and their best friend, from market-giant Apple to traditional watch titan Fossil Group Inc (NASDAQ:FOSL), is making a big push into the space.

Therefore, while Versa may be Fitbit’s best product yet, it is entering an exceptionally competitive marketplace that is only getting more crowded. There are no signs that Versa has any staying power in that highly competitive market, or that Fitbit can build on Versa’s near-term success through future products.

Meanwhile, all those smartwatch companies are also collecting the same data Fitbit is collecting, so Fitbit’s data is largely commoditized. Moreover, because Fitbit is smaller than Apple, Apple’s consumer healthcare data-set is presumably much bigger and more valuable.

Granted, Fitbit is agnostic, whereas Apple Watches work only with iPhones. From this perspective, Fitbit technically scales better. But, then we come back to the market share concerns. In the long run, how well will Fitbit smartwatches do against other smartwatches that aren’t under the Apple umbrella?

No one really knows, meaning that there is a lot speculation inherent to the Fitbit bull thesis.

The Valuation

Under aggressive modeling assumptions, I still don’t arrive at a fair value for Fitbit stock anywhere near $8.

Let’s say that revenues do bottom out at $1.5 billion this year and that smartwatches and data partnerships power 10% revenue growth over the next five years. Let’s also assume that gross margins stabilize around 40%, and that operating expenses stay around $800 million even amid increasing revenues.

Under those bullish assumptions, I still think Fitbit can do only about $0.50 in earnings per share in five years. A market-average 16-times forward multiple on $0.50 implies a four-year forward price target of $8. Discounted back by 10% per year, that equates to a present-day value between $5.50 and $6.

Bottom Line on FIT Stock

This rally in Fitbit has been nothing short of miraculous. While the fundamentals are strengthening through Versa and data partnerships, they aren’t strengthening by that much. Thus, at $8, Fitbit stock seems like a fade the rally situation.

As of this writing, Luke Lango was long AAPL and FOSL. 

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