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Betting on Lululemon's Flexible Future

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Shares of lululemon athletica (NASDAQ: LULU  ) slid into a downward dog position earlier this week after the yoga-inspired apparel company updated guidance for its fiscal fourth quarter. Here's the kicker: The company's revised guidance was to the high end of its original forecast. Still, the stock fell as much as 4% on the news. Let's take a look at why Mr. Market punished the stock, and what shareholders can expect from Lululemon in the year ahead.

What gives?
Management's amended guidance may have topped its previous estimates, but that hardly matters with a stock like Lululemon, which is priced to perfection. Trading at around 41 times earnings, the stock's sky-high valuation leaves little room for error. Additionally, increased competition in Lululemon's niche market has some analysts worried that the company's best days could be behind it.

Larger rivals including Nike and Under Armour are aggressively pushing into the yoga gear space. Not to mention, both of these athletic-apparel companies benefit from something Lululemon does not: broad distribution. While Lulu prefers to sell its products through its own corporate-run stores, Nike's and Under Armour's products are stocked in department and sporting good stores around the country.

But before you dump the stock, let's dig deeper into the facts and see what the company has in store for the rest of 2013. After all, Lululemon didn't become one of the most exciting growth stories in retail by chance. The company has earned its cult following through exceptional management and a distinctive corporate culture.

Stretching the brand
Let's not forget that Lululemon leads the retail pack in terms of sales per square foot, with $2,050 in sales per square foot at last check. This makes it the highest-productivity apparel retailer in North America, according to a company presentation given this week at the ICR XChange event.

To that end, the company's top store location rings in $27,000 worth of sales an hour . However, this isn't too shocking, because Lululemon sells its merchandise at a steep premium to industry peers.

Consider Limited Brands (NYSE: LB  ) , for example. Its Victoria's Secret branded workout apparel sells for a third of the price of similar merchandise from Lululemon. While this is good for Lululemon's sales-per-square-foot metric, it could cost the company market share down the road if shoppers opt for more affordable options.

Nevertheless, Lululemon continues to differentiate its offerings from the competition by way of innovative fabric solutions and the overall complexity and design of its products. It's also important to point out that the retailer is successfully expanding into new product categories including menswear, as well as youth dance apparel with its ivviva brand.

Show me the growth
Lululemon's future still look bright, despite the stock's recent volatility. As we settle into the new year, investors should watch for growth in the retailer's e-commerce channel. With e-commerce penetration currently 14% of total sales, Lululemon has a clear opportunity, both in the U.S. and abroad, to beef up its online business.

Investors should also keep an eye on Lululemon's overseas growth as the year progresses. The retailer's international strategy is already under way with distribution centers now servicing Europe, Asia, and Australia, as well as the United States and its native Canada.. With two showrooms now open in Hong Kong and one in London, Lululemon's future in these markets looks promising.

One of the strategies that Lululemon employs in foreign markets is what it calls "community connectors." These are representatives from Lululemon's team that set out in new markets to find the best yoga studios and fitness clubs in order to connect with community leaders and gather a better understanding of the local customers in each new market.

This is a very different marketing method from that of industry peers such as Nike and Under Armour, who spend hundreds of millions of dollars promoting their products with celebrity endorsement deals and pricey commercial spots.

While we will have to wait and see if this grassroots approach pays off in European and Chinese markets, it has so far served the company well in the U.S. and Canada. Today the upscale fitness brand has 211 stores worldwide, with 135 of those storefronts located in the United States. Lululemon plans to test demand for its products in more than 15 countries this year.

If successful, international expansion should help carry the stock higher over the next three to five years -- as the bulk of Lululemon's current profitability comes from within the U.S. and Canada. For this reason, current shareholders with a longer time horizon should sit tight and see how new store openings in Europe and Asia pan out.

Lululemon has been a pick of Motley Fool superinvestor David Gardner, and has risen more than 90% since he recommended it in December 2010. David specializes in identifying game-changing companies like this long before others are keen to their disruptive potential, and he helps like-minded investors profit while Wall Street catches up. I invite you to learn more about how he picks his winners with a free, personal tour of his flagship service: Supernova. Inside, you'll discover the science behind his market-trouncing returns. Just click here now for instant access.

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