I know this blog is beginning to sound like a broken record but yet another example has emerged – Fitbit. As the P/E multiple approached 50 on Monday, I could not resist writing call options. Not only did the stock appear overpriced, for the reasons discussed below, but the implied volatility was over 90%.
The rationale behind my decision is familiar. A P/E of 50 requires significant growth in free cash flow – not revenues. Sustained growth in free cash flow requires meaningful, long-term barriers to entry. When it comes to wearable fitness tracking devices, it is hard to imagine a more competitive business. Not only is the space filled with big players like Apple, Samsung and Microsoft, but there are also a host of smaller companies like Pebble, Jawbone and Garmin jockeying for market share. Where the “moats” around Fitbit’s products in such a situation?
Despite my overall belief in its efficiency, the stock market seems to periodically confuse growth in a sector (electronic watches and fitness trackers) with growth in the profitability of companies within the sector. Unfortunately, it is quite possible for the sector to grow rapidly while competition prevents most (if not all) of the competitors from making a killing. In my view, Fitbit will turn out to be another example.