Oh, how the mighty have fallen. Since hitting a record of $511.29 at the end of 2023, share prices of Lululemon Athletica (NASDAQ: LULU) have cratered 44%. This is despite the S&P 500 generating an impressive 18% total return during the same period.
To be clear, this apparel stock has still been a massive market outperformer in the past decade (up 650%). However, investors have become pessimistic about the state of the business.
What’s the best course of action? Should you buy the dip in this growth stock? Let’s assess both the bear and bull arguments for Lululemon and see if an answer presents itself.
The apparel industry makes it hard for Lululemon to sustain success
Lululemon is known for selling high-quality athletic and lifestyle apparel at premium prices. This has positioned it well historically. But the intensely competitive nature of the apparel industry is hard to ignore. There are no barriers to entry. This means that anyone with an idea and access to capital can start designing and selling clothing, which has become even easier with the advent of the internet.
Moreover, consumers have zero switching costs. They are free to be as loyal or disloyal as they please, spending their money on whatever clothes or shoes they like at any given time.
It’s also worth mentioning just how difficult it is to find sustained success in this industry. Consumer tastes seem to always be changing. I’m not sure anyone could’ve predicted the resurging popularity of looser clothing these days.
In Lululemon’s case, it faces stiff competition across the board, from industry heavyweights like Nike and Adidas to smaller rivals like Vuori and Alo Yoga. This just means that the business must stay on top of its game in terms of product innovation. During the latest fiscal quarter (Q1 2024 ended April 28), Lululemon’s sales rose 10% year over year. While a healthy gain in its own right, that represented a slowdown from previous quarters. Perhaps the market thinks that Lululemon’s days of dominance are over.
There are reasons to be bullish about Lululemon
I fully accept and understand the bear case outlined above. But I believe Lululemon still merits consideration as a portfolio addition right now.
This company possesses a strong brand. In the past five years, Lululemon’s gross margin has averaged a superb 56.5%. This indicates pricing power, or the willingness of consumers to pay up for what they must believe is a differentiated product offering.
Lululemon is also very profitable, which you wouldn’t immediately assume when looking at the stock’s disappointing performance this year. The business generated $1.6 billion in free cash flow in fiscal 2023 on revenue of $9.6 billion, good for a fantastic margin of 16.7%. This allows management to continuously repurchase shares.
Despite the recent sales slowdown, it’s hard not to get excited about the company’s long-term prospects. Lululemon only generated 27% of its Q1 2024 revenue outside the U.S. and Canada. Consequently, international markets, particularly China, present a huge opportunity.
The final reason investors should think about buying the stock comes down to valuation. Lululemon shares traded at a price-to-earnings (P/E) multiple of 97 in the fall of 2020 during the pandemic-influenced stock market boom. A valid argument could have been made that the stock wasn’t investable at that lofty level.
However, the valuation is much more attractive today. Shares trade at a P/E ratio of 23.1. For comparison’s sake, the S&P 500 sports a P/E multiple of 24.4.
Lululemon’s slight discount to the overall market might not be warranted. According to Wall Street consensus analyst estimates, the business is expected to grow revenue and earnings per share at compound annual rates of 10.9% and 11.7%, respectively, between fiscal 2023 and fiscal 2026. This favorable outlook is yet another reason to buy Lululemon stock.
Should you invest $1,000 in Lululemon Athletica right now?
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Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Lululemon Athletica and Nike. The Motley Fool recommends the following options: long January 2025 $47.50 calls on Nike. The Motley Fool has a disclosure policy.
Down 44%, Should You Buy the Dip in This Growth Stock? was originally published by The Motley Fool
