Peloton ran off the road and the market followed

Stocks gave up early gains to close in the red yesterday after a negative report about lock-down darling Peloton hit the tape. The Nasdaq reversed a more than +2% gain in a sharp selloff into the close.

Saddle soar.  I feel like I might be sounding like a broken record, but risk is inexorably connected to return. Now, I am not going to go into the math, it is Friday, and you deserve better, however I need to get the message across somehow. Here is the scene: it is a high stakes Formula 1 auto race with just a few laps left. Two drivers are neck and neck, both fighting for the podium’s top spot, but more importantly the title of World Champion. The reigning champ, with his superior car and decades of experience is ahead by a car length. The would-be usurper is a young, talented, and feisty driver who has distinguished himself as a future champ.  Exactly when the mantle will be passed could be determined over the next two laps. Got it? A lot is at stake for both drivers…back to the race. Both cars speed down a strait at around 310 kilometers per hour (that is about 195 MPH for you metric haters) heading into a sharp turn. The cars are going so fast that sparks are flying from their undercarriages scraping the ground as their engines whine at a high pitch. The champ is confident and a master of the craft. He knows just when to apply his brakes to maximize his speed through the apex of the turn without flying off the track and into the grass. The challenger with far less experience, but almost equal skill, also knows how to optimize the high-speed turn, but there is one subtle difference between the two drivers.  The younger driver knows that without taking any risk, he will end up missing his opportunity and go home empty-handed for the season. He must make a quick risk / reward decision. As both cars enter the turn the young driver decides to brake a bit late. At those speeds, late braking will, most of the time, lead to misadventure in the grass or even in the wall of tires. If executed successfully, the challenger could pass the incumbent champ in the turn. He decides to take the risk…which results in his winning the race and ultimately, the championship. The new champ could have ended up not only out of the race altogether, but possibly with bodily harm to himself and other drivers. He took the risk and got the reward. That would not be the first time the new champ attempted that risky maneuver. He executed it time and again throughout the season, and sometimes he ended being forced to retire with a crash, but other times he was successful. Indeed, he succeeded more than he failed, which is how he ended up with the coveted title. Looking back on the fails, even the epic ones, that driver never made excuses and never worried about the temporary setbacks. He knew the risks and focused on the rewards and his longer-term goal of gaining the World Drivers’ Champion title.

We take similar risks every day in our investments. We have choices which each have their own flavor of risk. We can get market return and the risk associated with it by investing in the broader markets with mutual funds and ETFs. However, if we want to get extra-market returns (that is a cool way of saying beat the market), we must be willing to take more risk. How much more risk is directly correlated with the level of greater return… or greater loss. We can select investments which are less risky than the market if we are uncomfortable with risk or if we can’t afford losses, but by doing so, we cannot expect to beat the market.  Investors in Peloton (PTON) who had the insight to buy the upstart fitness stock in March of 2020 were rewarded with a +471% gain through the end of the year. The S&P500 through that period had a spectacular return of +45.33%. In its first full quarter of being a public company, PTON announced a loss of -0.18 per share. The company’s products were in high demand as the pandemic struck, revenues began to grow, and by June of 2020, the company became profitable.  Revenue went from $524.6 million to $607.1 million. They continued to climb through the end of 2020 with calendar Q3 and Q4 revenues coming in at $757.9 million and $1.0648 billion, respectively. Profitability and revenue growth certainly drove the stock’s spectacular returns.  2021 was set to be a good year for the company.  Remember those two Formula 1 cars speeding into the defining corner? For the first quarter of 2021, the company announced revenues of $1.2623 billion, more than doubling the revenue of the same quarter just a year earlier. By the end of the second quarter of 2021, Peloton’s revenues came in at just $936.9 million, a quarter over quarter decline. Moreover, the company announced a quarterly EPS loss of -0.63, its first quarterly loss since March 2020. It was clear that, for investors, a decision had to be made. Should they brake late and get the extra-market returns of 2020, or trim their positions and go the conservative route? A similar call had to be made by investors when the Q3 results were announced. Quarterly revenues had receded further to $805 million with an EPS loss of -1.17. Brake late and go for the win, or cut losses, sell the stake, and invest in the market? Yesterday’s news that Peloton halted its production of bikes and treadmills due to a slowdown in demand was clearly taken by the market in the most negative way. Was it just smart inventory management or was it a sign of trouble? The market clearly decided that it was the latter which not only caused a massive selloff in the stock itself, but the market as a whole, which suffered an epic reversal into the close. If investors simply looked at the diminishing quarterly revenues, it would have been clear that demand for its products, while still good, was waning. Yesterday’s revelation should not have come as a surprise to diligent investors. It was clear that the grass and the wall of tires was coming up fast. Stay focused, stay diligent.

WHAT’S SHAKIN’

Netflix Inc (NFLX) shares are lower by -19.63% in the pre-market after it announced an earnings beat of +64.51 but a revenue miss of -0.03%. The company announced that it had added +18.2 million subscribers in 2021, which amounted to an almost -50% growth decline from 2020. It further, projected that the slowdown in growth would continue into the coming quarter, a result of increased competition from other streaming services. Netflix is a growth company in which investors expect continued, great growth in revenues and earnings. Anything short of that diminishes the value of the company. Refer to the Formula 1 race above for some more color.  Potential average analyst target upside: +13.0%.

Under Armour Inc (UAA) shares are trading higher by +1.94% in pre-market after Citigroup upgraded the stock from NEUTRAL to BUY. The analyst upgraded the company due to its attractive outlook, particularly with solid growth potential in the European and Asian markets where its brand has been well received. The company’s shares have been under pressure since late last year.  Potential average analyst target upside: +55.3%.

Zoetis (ZTS) shares are up by +1.51% in pre-market after announcing yesterday that the FDA approved its Solensia product for osteo arthritis pain relief in cats. The company will announce its Q4 earnings on 2/15. Dividend yield: 0.64%. Potential average analyst target upside: +21.3%.

YESTERDAY’S MARKETS

Stocks reversed early gains and closed with losses after a report on Peloton’s woes spooked nervous investors. The S&P500 fell by -1.10%, the Dow Jones Industrial Average traded lower by -0.89%, the Nasdaq Composite Index dropped by -1.30%, the Russell 2000 Index was off by -1.81%, and the S&P500 ESG Index gave up -1.07%.  Bonds gained and 10-year Treasury Note yields gave up -6 basis points to 1.80%. Cryptos gained +2.0% and Bitcoin slipped by -0.95%.

NXT UP

  • Leading Economic Index (Dec) is expected to have grown by +0.8% after rising by +1.1% in November.
  • Earnings season will be in full swing next week. In addition, we will get more housing numbers, Consumer Confidence, Durable Goods Orders, GDP, PCE Deflator, and University of Michigan Sentiment. The real showstopper will be the FOMC meeting mid-week. Check back on Monday for calendars and details.

IMPORTANT DISCLOSURES.

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