What a brutal six months it’s been for Peloton. The stock has dropped 37% and now trades at $4.64, rattling many shareholders. This might have investors contemplating their next move.
Is there a buying opportunity in Peloton, or does it present a risk to your portfolio? Get the full stock story straight from our expert analysts, it’s free.
Why Do We Think Peloton Will Underperform?
Despite the more favorable entry price, we're sitting this one out for now. Here are three reasons we avoid PTON and a stock we'd rather own.
1. Decline in Connected Fitness Subscribers Points to Weak Demand
Revenue growth can be broken down into changes in price and volume (for companies like Peloton, our preferred volume metric is connected fitness subscribers). While both are important, the latter is the most critical to analyze because prices have a ceiling.
Peloton’s connected fitness subscribers came in at 2.88 million in the latest quarter, and over the last two years, averaged 4% year-on-year declines. This performance was underwhelming and implies there may be increasing competition or market saturation. It also suggests Peloton might have to lower prices or invest in product improvements to grow, factors that can hinder near-term profitability. 
2. EPS Trending Down
Analyzing the long-term change in earnings per share (EPS) shows whether a company's incremental sales were profitable – for example, revenue could be inflated through excessive spending on advertising and promotions.
Sadly for Peloton, its EPS declined by 31.7% annually over the last five years, more than its revenue. This tells us the company struggled because its fixed cost base made it difficult to adjust to shrinking demand.
3. Mediocre Free Cash Flow Margin Limits Reinvestment Potential
Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
Peloton has shown poor cash profitability relative to peers over the last two years, giving the company fewer opportunities to return capital to shareholders. Its free cash flow margin averaged 9.8%, below what we’d expect for a consumer discretionary business.
Final Judgment
We cheer for all companies serving everyday consumers, but in the case of Peloton, we’ll be cheering from the sidelines. Following the recent decline, the stock trades at 16.5× forward P/E (or $4.64 per share). While this valuation is fair, the upside isn’t great compared to the potential downside. There are better stocks to buy right now. We’d suggest looking at the Amazon and PayPal of Latin America.
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