Thursday, October 22, 2015

Not so "fit" Fitbit

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.

Wednesday, October 14, 2015

Tesla Once Again and "Short-termism"

            To follow up on the previous post, let’s consider Tesla, the other stock that has been consistently discussed here as being overvalued.  Before getting to valuation, it is worth noting that Tesla is one example among many that contradict the view that the market is “short-term oriented.”  It is surprising how often this evidence is ignored in light of the fact that concern regarding "short-termism" has even spread to presidential candidates.  The fact is that all Tesla offers in the short-term are small profits or losses.  Nothing that can remotely justify its $30 billion (or so) valuation.  The only way to rationalize that valuation, particularly in light of the difficulty of growing rapidly in the automobile industry, is to conclude that the market is taking a very long view with respect to Tesla.  It sees big profits in the distant future.

            But then why does Tesla react, in some cases quite strongly, to short-term information?  To start, if what is meant by short-term is current information that is all there is.  Given that all new information is current, the relevant question is whether the current information has long-term implications, at least in the view of investors.  And that turns out to be an extremely difficult question to answer.

            A big reason for the difficulty is that information can accumulate and then suddenly have an impact on long-term views when a critical juncture is reached.  For instance, Tesla investors may largely ignore bad short-term news such as delays in the Model X for a while.  But if that news accumulates, at some point it will undermine their confidence in the company’s long-term growth.  At that point, the stock price will collapse.  However, there is no objective way to measure how information is accumulating in the minds of investors or what their thresholds are.  This is what makes shorting stocks such as Tesla so risky.  There is no way to predict how long it will take for investors to change their minds or what type of information will cause the change.  Eventually, of course, the stock price must drop if it becomes clear that the expected growth in future cash flows will not be realized.  But eventually can be a very long time.  As long as investors believe that future growth is coming, the stock price will not fall.

Monday, October 5, 2015

Go Pro "Went"

     A little over a year ago I posted an article calling GoPro wildly overvalued at a price of $75 per share.  I argued that the barriers to entry and the growth opportunities simply could not support a price-earnings ratio of over 250.  Suppose you agreed and decided to go short GoPro or write call options.  When do you make money?  Not until the market agrees with you.  And as Keynes noted nearly a century ago who knows when that will be.  The fact is that to make money, particularly on short positions, it is not enough to be right - the market has to accept your conclusion.

     What is odd that such agreement tends to arrive suddenly and for unclear reasons.  Since I posted my blog, Go Pro has done very well - sales and profits have both been growing sharply.  But not as sharply as investors apparently hoped.  In the last couple of months, the stock price has collapsed to less than 30, down more than 60%.  But the decline was hardly linear.  In fact, following the post the stock got as high as $90 per share.  I still believe that in the long run fundamental investing is the only way to make superior risk adjusted returns.  But waiting for the long run may be harrowing.

PS.  Currently, the P/E of GoPro has fallen to about 25.  In my view, the stock is now about fairly priced.