The Case For Nike Stock vs. a Stumbling lululemon

Accidentally producing see-through pants is an amateur’s mistake anyway you look at it, and it’s not the first such flub young lululemon athletica (LULU) has made in recent months. Meanwhile, granddaddy Nike (NKE) just produced a breathtakingly good earnings report. Highlights included sizable sales growth despite its gargantuan size and evidence of quickly fixing a problem that would have crippled a lesser company. So which is the better investment in this business of trendy athletic attire: the adolescent or the godfather?

LULU Chart

LULU data by YCharts

There are great advantages of investing in a young, growing company, and until recently, lululemon shareholders had seen them all, as seen in a stock chart. Revenue gains are obviously easier to achieve when you’re starting from hundreds of millions instead of billions, and when most of the world, domestically and otherwise, represents virgin territory for your mere 200 stores. A very popular product, like the $99 yoga pants that made lululemon famous, can lead to big profit margins. The combination of all the above can turn into phenomenal share price gains that are all but impossible in bigger, older companies. Ten bagger? Lululemon shares were closer to a 17-bagger between 2009 and mid-2012.

But fast growth is very difficult to manage gracefully, and mistakes will be made. Lululemon says the recall of those transparent pants will cost it roughly $62 million in sales, which is about 3.8% of the $1.63 billion in now projects for 2013 revenues. Before that, the company had reported problems with dyes that bled out of some fabrics and supply chain issues that slowed production. With year-over-year revenue growth still in the high 30% to 50%, investors let this news slide.

Yet lululemon is at a point in which its great growth will surely slow naturally, even if it flawlessly executes its future. Comparable store growth is slowing down already. Many competitors, including Nike, The Gap (GPS) and even Nordstrom’s (JWN) included, have launched copycat products. Perhaps the market does not really need hundreds more niche-y athletic wear shops.

It’s the sort of intersection of events that make investors notice the incredible PE ratios they were happy to ignore before. Its share price floated much of this year before the pants issue shot it down 16% against the S&P 500’s 6.5% gain. Its forward PE ratio, which travelled north of 40 for most of the past two years, is still at a lofty 28.

LULU Forward PE Ratio Chart

LULU Forward PE Ratio data by YCharts

Nike shares haven’t traded at lululemon valuations for many years because there is no way its $25.5 billion in revenues can make the kinds of gains relatively tiny lululemon might with new stores. But Nike is forecasting underlying sales growth of about 10% in its coming fiscal year, which is equal to lululemon’s revenue projection. Nike’s recent earnings beat forecasts, largely by addressing an international problem a lot of followers considered intractable. (It involved weak sales in China, which is a problem many U.S. corporations are facing. Nike unexpectedly improved its profit margins there.) Nike pays an ever-increasing dividend, up about 500% during the past decade, and the dividend yield is 1.6% now, and it buys back shares to bolster the stock. (The dip in the chart represents a stock split.) Nike doubled its share price between 2009 and 2012, and it’s up another 15% this year.

NKE Dividend Chart

NKE Dividend data by YCharts

The investment community is divided over whether the latest stumble will be just a blip on lululemon’s upward trajectory or the beginning of real trouble for its investors. Wall Street seemed to be casting about for a new valuation on the company even before the news. Nike represents an alternative to the drama, where investors are rarely bothered with worries about undignified pants.

Dee Gill, a senior contributing editor at YCharts, is a former foreign correspondent for AP-Dow Jones News in London, where she covered the U.K. equities market and economic indicators. She has written for The New York Times, The Wall Street Journal, The Economist and Time magazine. She can be reached at editor@ycharts.com.

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