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It was the sort of stock price crash that’s usually reserved for steep losses or results that significantly fall short of forecasts. That wasn’t the case for Lululemon Athletica (NASDAQ: LULU), whose stock plunged 16.4% Thursday on what appeared to be a pretty strong second-quarter earnings report.
The maker and retailer of fashionable yoga gear reported that net income – while down slightly from the year-ago quarter – surpassed analyst estimates, while its total sales jumped 16% and same-store sales grew by a healthy 11%. The company’s direct-to-consumer revenue rose 30%. And there was more good news as the company raised revenue guidance for the full year.
So what gives? Here’s a short list of key factors behind the Lululemon stock plunge on Thursday and some thoughts on whether it was an overreaction or a needed adjustment.
1. Inventories are growing. Analysts who follow the company were quick to home in on the detail that Lululemon ended the quarter with inventories of $280.6 million, a full $100 million higher than where they stood at the end of last year’s second quarter. High inventories can potentially signal both a coming slowdown in business or just poor management. Both are troubling for a retail business that must deftly manage supply and demand each season.
2. The company’s fastest-growing segment is one of its smallest. While Lululemon saw some of its best retail growth in its direct-to-consumer segment, this segment accounts for less than one-fifth of the company’s total revenues.
3. The business can’t live up to the hype. Last quarter I wrote that, strong growth notwithstanding, it was hard to justify Lululemon’s stratospheric price/earnings ratio of 41. That’s not so much of a problem after the Lululemon stock plunge on Thursday took its price down to the lowest level seen since last December. But it’s still not clear whether Lululemon, with a current price/earnings ratio around 28, is fairly valued. In this respect, stocks are a little like houses: The more expensive they get, the harder it is to understand their value. People might generally agree on the value of a $200,000 home but debate whether one ten times as large is worth $2 million or $4 million. Over the past year Lululemon became something of a gold-plated stock and it is going to take some time to separate the hype that inflated it from the underlying value.
4. Markets are volatile. This is a tricky time to be an investor. Often in times of volatility, the stocks that get hit the hardest are the ones that had become popular among retail investors who liked the company but may have liked the stock a little too much. Time will tell what’s in store for Lululemon shares, but its stock crash on Thursday is a cautionary tale for investors to think very carefully before buying shares, even in the companies they like and think they understand. And until we have more visibility you’d be better off keeping your love of Lululemon in the yoga studio.
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