Lululemon: A Second Chance for a Great Growth Stock

When a beautiful growth stock takes a dive that lasts more than a few weeks, the party’s usually over for good. No one wants to pay growth prices for has-been shares, even if they did once spin off triple-digit returns. But lululemon athletica (LULU), which investors appeared to have written off two months ago, is getting a second chance.

Investors this week were paying 50-plus times earnings for lululemon shares. So, LULU’s PE exceeds even the share price in early 2011, when it had just climbed more than 380% in six months. Shares now trade near the 52-week high mark, some 28% higher than they did a month ago.

lululemon athletica Stock Chart by YCharts

This was no buying on exaggerated ratios. Lululemon, a fast-growing retailer selling fashionable yoga and workout clothes, had no gigantic earnings drop that might put in question the meaning of those valuations. The $6.65 billion market cap LULU has booked strong earnings and revenue growth ever since going public in 2007.

lululemon athletica Revenues TTM Chart by YCharts

Instead, this looks like a big case of seller’s remorse. Forecasts that sparked last year’s selling don’t look all that dire in retrospect. (At one time, the company warned that same-store sales growth would probably drop a few percentage points to the low-to-mid teens.) Earlier this month, Barclays (BCS), Goldman Sachs (GS) and KeyBanc (KEY) Capital Markets hit lululemon with buy recommendations, arguing that its price isn’t that high considering its continuing sales growth. On Tuesday (Jan. 10th), lululemon announced that fourth quarter profit and revenue would be higher than expected.

Lululemon’s fans point out that rampant sales growth there typically translates quickly into shareholder gains. The company has a great balance sheet and no debt – YCharts Pro gives it excellent marks for fundamentals – and earnings growth tends to keep up with sales. It helps that lululemon’s profit margins consistently outdo other retailers. The company consistently keeps more from the sale of its $98 yoga pants than Nike (NKE) or Under Armour (UA) make from selling shoes and shirts.

lululemon athletica Gross Profit Margin Chart by YCharts

So as an investment, can lululemon be a 10-bagger once again? Despite conventional wisdom, its past success doesn’t jinx returns going forward unless sales and earnings growth don’t hold up. And there’s little reason to believe lululemon’s growth is falling off. With huge demand for its product (it outstripped inventory at times last year), the company needs to open a lot of new stores just to keep up. At the end of the third quarter, its stores numbered just 165 in North America and Australia; far from saturation. It’s a problem Lulu’s management team tends to handle very well.

The bigger danger for LULU shareholders lies in investors’ general lack of loyalty to growth stocks. As lululemon’s year-end share price decline demonstrates, investors will sell this stock in waves whenever the company reports something mildly disappointing. Actually, they’ll sell this stock at the first hint of less than fantastic news. Just keep in mind that next time, they may not want to buy it back.

Dee Gill is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings and portfolio strategies.