Many investors find it difficult to avoid so-called price anchoring. People, of course, want investments to at least break even when prices fall after a purchase. Of course, telling the bottom of a market or an individual stock is not likely, and if it does it depends on luck.
However, timing shouldn’t be a huge concern for long-term investors. But the same psychology drives the desire to buy stocks that have fallen in price. And if a soaring growth stock like Peloton interactive (NASDAQ: PTON) goes through a price correction, it is worth investigating more closely that it is a good idea to seize the opportunity.
Image source: Getty Images.
A perfect storm
The connected home fitness company was one of the darlings of the 2020 stock market with a stock return of more than 400%. It was a top game for the home as sales skyrocketed. Total sales in fiscal 2020 (which ended June 30, 2020) doubled compared to the previous fiscal year.
The growth continued through 2021, as sales for the 30th came in, but 2021 has now seen the opposite reaction for the stock. Stocks are down 32% year to date and nearly 10% last month.
Investors have traded stay stocks for those believed to benefit most from the reopening. Add to this poor publicity for the company having to recall its treadmills due to a safety issue, along with the recently announced price cut on its exercise bikes, and the perfect storm that fueled last year’s stock gains seems to have subsided.
Approach a good problem
One of Peloton’s biggest problems over the past year has been one that most companies would envy. The increasing demand for its products resulted in long lead times and delayed deliveries. Management quickly addressed the delivery issues. In December 2020, the company announced an agreement to purchase Precor, one of the world’s largest providers of commercial fitness equipment. That would create additional production capacities.
As it worked to complete that transaction, the company said in February 2021 it would invest $ 100 million to cover expedited air and ocean freight that would deliver orders faster. By May 2021, the company had completed the Precor acquisition, announced plans to build its first U.S. factory, and said average waiting times for its bikes were back to pre-pandemic levels.
Image source: Peloton Interactive.
The recurring source of income
One of the reasons the stock fell recently was the announcement that Peloton cut the price of its original bike by $ 400. But when what was meant to be a product only for the wealthy is now more affordable, the lower device revenue will eventually be replaced by recurring subscription revenue. In the fourth fiscal quarter ended June 30, 2021, subscription revenue increased 132% year over year, compared to a growth of just 35% for connected fitness hardware.
For the full year, subscription income represented 22% of total sales. But that is growing: In the fourth fiscal quarter it was 30% of total sales. And subscription income has a much higher gross profit margin than connected fitness hardware income.
Management expects the faster growing recurring revenue will help increase its gross margin by 700 basis points for fiscal year 2022 compared to the last quarter. And even considering the reduced hardware prices, Peloton is leading investors to expect total revenue to grow 34% in fiscal 2022.
Pay for growth
It’s not surprising that a growth stock like Peloton is expensive based on its current business metrics. However, applying the sales forecast for the 2022 financial year, the share will be traded at a price-to-sales ratio of less than 6. That’s a drop from about 18 at the beginning of 2021. And given the popularity of the product and continued growth rates in sales, that’s not not unreasonable.
But the company is not only growing in its core business, but also in the commercial sector thanks to the Precor acquisition. And it just announced the launch of Peloton Apparel, a private label line of fitness apparel.
Management’s strategy of growing its customer base by lowering device prices makes sense. Once a customer buys a bike or a treadmill, it is difficult to cancel the subscription service. And since subscription income offers higher margins, you see a clear path to profitability for Peloton.
With a new clothing store and hardware for commercial locations just getting started, the future of Peloton looks bright. Now seems like a good opportunity to take advantage of the fall in prices and buy in before the stock rises again.
This article represents the opinion of the author who may disagree with the “official” referral position of a premium advisory service from the Motley Fool. We are colorful! Questioning an investment thesis – even one of our own – helps us all think critically about investing and make decisions that will help us get smarter, happier, and richer.
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