Should you buy Peloton before it goes up?

Many investors find it difficult to avoid what is known as price pegging. People naturally want investments to at least return to equilibrium if prices fall after making a purchase. Of course, timing the bottom of a market or an individual stock is unlikely and it depends on luck if it does.

However, timing shouldn’t matter much to long-term investors. But this same psychology drives the desire to buy stocks that have fallen in price. And when a high-flying growth stock like Interactive Platoon (NASDAQ: PTON) is undergoing a price correction, it is worth taking a closer look at whether it is a good idea to take advantage of the opportunity.

Image source: Getty Images.

A perfect storm

The connected home fitness company has been one of the darlings of the 2020 stock market, with a stock return of over 400%. It was a top home game as sales skyrocketed. Total revenue doubled for its fiscal year 2020 (which ended June 30, 2020) compared to the previous fiscal year.

Growth continued in 2021, with sales increasing an additional 120% for the year ending June 30, 2021, compared to the previous 12-month period. But 2021 has now seen the opposite reaction to the stock. Shares are down 32% year-to-date and nearly 10% just in the last month.

Investors traded home stocks for those who would benefit the most from the reopening. Add to that bad publicity from the company that had to recall its treadmills due to a safety issue, as well as the recently announced price drop for its exercise bikes, and the perfect storm that resulted in last year’s stock gains appearing to have subsided.

Solve a good problem

One of Peloton’s biggest issues last year was one that most companies would envy. The growing demand for its products has resulted in long delivery times and delivery delays. Management quickly resolved the supply issues. In December 2020, he announced an agreement to purchase Precor, one of the world’s largest suppliers of commercial fitness equipment. This would provide additional production capacity.

As it worked to close the deal, in February 2021 the company said it would invest $ 100 million to cover expedited air and ocean freight that would allow orders to be delivered faster. By May 2021, the company completed the acquisition of Precor, announced plans to build its first plant in the United States, and said average wait times for its bikes had returned to pre-pandemic levels.

woman finishing training on Peloton bike.

Image source: Peloton Interactive.

The recurring revenue stream

One of the reasons the stock fell recently is the news that Peloton has reduced the price of its original bike by $ 400. But if what was seen as a product intended only for the rich are now more affordable, the lower revenues from equipment will eventually be replaced by recurring subscription revenues. In the fiscal fourth quarter ended June 30, 2021, subscription revenue grew 132% year-over-year, compared to growth of just 35% for connected fitness equipment.

Over the full year, revenue from subscriptions represented 22% of total revenue. But it’s increasing: it accounted for 30% of total revenue in the fiscal fourth quarter. And the subscription revenue has a much higher gross profit margin than the revenue from connected fitness equipment.

Management expects the faster growing recurring revenues to help increase the gross margin by 700 basis points for fiscal 2022 compared to the most recent quarter. And even taking into account the reduction in hardware prices, Peloton is urging investors to expect a 34% increase in total revenue for its 2022 fiscal year.

Pay for growth

It’s no surprise that a growth stock like Peloton is expensive based on its current business metrics. But using its revenue forecast for FY2022, the stock is trading at a price-to-sell ratio of less than 6. This is down from around 18 at the start of 2021. And given the popularity of the product and continued growth rates in sales, that’s not unreasonable.

But the company is not only growing in its core business, it is also expanding in commercial equipment thanks to the acquisition of Precor. And he just announced the launch of Peloton Apparel, a private label fitness clothing line.

Management’s strategy of increasing its customer base by lowering equipment prices makes sense. Once a customer purchases a bicycle or treadmill, the subscription service is hard to give up. And since subscription revenue offers higher margins, you can start to see a clear path to profitability for Peloton.

With the start of a new clothing and equipment business for retail locations, Peloton’s future looks bright. Now looks like a good opportunity to take advantage of the price drop and buy before the stock rises.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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