Has lululemon athletica Become the Perfect Stock?

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock and then decide whether lululemon athletica (NASDAQ: LULU  ) fits the bill.

The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
  • Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Moneymaking opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
  • Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
  • Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at lululemon athletica.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-year annual revenue growth > 15%

38.4%

Pass

 

1-year revenue growth > 12%

36.9%

Pass

Margins

Gross margin > 35%

55.7%

Pass

 

Net margin > 15%

19.7%

Pass

Balance sheet

Debt to equity < 50%

0%

Pass

 

Current ratio > 1.3

5.90

Pass

Opportunities

Return on equity > 15%

36.3%

Pass

Valuation

Normalized P/E < 20

38.70

Fail

Dividends

Current yield > 2%

0%

Fail

 

5-year dividend growth > 10%

0%

Fail

       
 

Total score

 

7 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at lululemon athletica last year, the company has kept its seven-point score for the third year in a row. The stock, though, hasn't kept up the pace, falling 15% over the past year.

Lululemon has vaulted onto the athletic apparel scene in recent years, with its focus on yoga apparel creating and defining a new niche. With customer-centered moves like having yoga ambassadors recommend its products, Lululemon has seen spectacular growth.

What has sent shares falling recently, though, is the combination of sky-high multiples and fears that Lululemon's high growth rates are starting to slow. In its earnings report last week, Lululemon reported 31% higher revenue for the quarter and a profit gain of nearly 50%, beating analysts' expectations and capping a 2012 that saw sales rise nearly 37% and the bottom line grow 47%. Yet shares tanked after the company recalled some of its yoga-pant lines because of quality-control issues. Moreover, with Lululemon having to cut its 2013 guidance in light of the recall, it looks like growth will slow down considerably this year.

The real question that Lululemon faces now is whether competitors will be able to swoop in and take advantage of its miscues. Gap's (NYSE: GPS  ) Athleta line of stores, which sell yoga and other athletic apparel, has played a key part in the retailer's comeback in 2012, and Gap has plenty of capacity to expand further. Meanwhile, Nike (NYSE: NKE  ) has used its marketing muscle to bring in yoga representatives of its own to support its competing lines.

Given these problems, it will be tough for Lululemon to get much closer to perfection than it already is. In fact, if sales and earnings start to stagnate, Lululemon could end up losing ground in the years to come.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

Lululemon has the potential to grow its sales by 10 times if it can get through its recent recall debacle. Find out how Lululemon can bounce back by reading our premium research report on the yoga retailer. Thousands have already claimed their own premium ticker coverage, and you can gain instant access to your own by clicking here now.

Click here to add lululemon athletica to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.


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