Very few stocks that fall 90% ever recover losses for investors. Through the effects of competition a lot of companies see their advantages erode, leading to weaker financial performance over time. This is how many investors view GoPro (GPRO 0.89%), the active lifestyle camera company that went public around a decade ago.

After a hyped-up initial public offering (IPO), the company’s stock fell precipitously and is now off 95% from its highs due to a quick drop in demand for its camera products.

GPRO data by YCharts

While it’s usually not wise to bet on a stock that dropped 90%, there are signs that GoPro’s business is actually in a healthy spot and could be getting undervalued by public market investors. Here’s why the stock may be set up for a turnaround in 2023. 

Crawling back from the dead through subscriptions

If you just compared GoPro’s hardware shipments from 2022 to 2014 (the year it went public) you wouldn’t be surprised to see the stock down.

In the third quarter of 2022, the company shipped 797,000 cameras to customers, down from more than 1 million in Q3 2014. The company’s revenue peaked around the 2016 time frame at just under $2 billion and never recovered. Over the past 12 months, it has generated $1.16 billion in sales, which has changed little in the past five years.

However, since 2018, GoPro’s operating income started to climb higher in spite of zero revenue growth. Over the past 12 months, operating income was $96 million compared with a loss of $94 million in 2018.

GPRO Operating Income (TTM) data by YCharts

How did GoPro’s profits recover if overall revenue fell? Two reasons.

First, it laid off a lot of workers, going from 1,722 workers in Q3 2016 to 927 in Q3 2018 to 860 today. Fewer personnel means less expense for the company, which leads to higher operating margins.

Second, GoPro successfully built a subscription business for its high-usage customers. GoPro subscribers pay $49 a year and get cloud storage, free camera repairs, and premium editing tools on the GoPro app.

Last quarter, the segment hit 2.1 million subscribers, up 55% year over year and up significantly from under 500,000 back in 2020. With high gross margins in the 70% to 80% range, GoPro’s subscription business is a key reason why operating income has turned positive even though consolidated revenue hasn’t changed much.

Valuation: Very attractive

With the stock down 95% from its highs, GoPro trades at a market cap of about $776.5 million. Over the past 12 months, the business generated a net income of $78.4 million, giving the stock a trailing price-to-earnings ratio of just under 10. For a business in a challenging consumer market that has shown a minimal ability to grow its revenue, this feels like a fair price for the stock. 

But if you look under the hood, there are signs that revenue growth could pick up steam over the next few years due to the scaling of the GoPro subscription business.

Last quarter, subscription revenue was $20.9 million, up from just $4 million in Q3 2019. Next year, the segment will likely do well over $100 million in high-margin revenue. While only a small portion of GoPro’s $1 billion-plus annual revenue base, it should start to drive some consistent growth if it can reach $200 million or more in annual revenue over the next few years.

Plus, with high gross margins, this revenue will be even more accretive to consolidated earnings growth.

One big risk

So GoPro stock looks cheap right now. But where would any potential downside come from? Why would the stock be lower a few years from now?

My big concern is looking at rising hardware inventory, a leading indicator of softening consumer demand for GoPro products. Last quarter, total inventory was $153.4 million, up from $120.9 million a year ago. Anyone who buys this stock should watch what inventory does over the next few quarters as rising inventory could be a sign that sales will be lower next year after the economy lapses the stimulus-driven era of 2020 and 2021. 

The inventory risk is there, but as long as subscribers continue to grow along with steady hardware demand, GoPro stock looks like it is finally ready to make a turnaround in 2023.