Lululemon Athletica's (LULU 0.59%) improved sales performance in 2021 hasn't kept the stock from falling victim to the recent market correction. The stock price has fallen 37% after reaching an all-time high of $485 a share in November.
It didn't help that the fast-growing retail brand released disappointing updated guidance for the holiday quarter. Let's unpack why Lululemon stock is down and why it would be a mistake to sell at the moment.
Image source: Lululemon Athletica.
Why Lululemon stock is falling
Management now expects revenue to be at the low end of its previous guidance range of $2.125 billion to $2.165 billion. It expects adjusted (non-GAAP) earnings per share (EPS) to also come in at the lower end of the range of $3.25 to $3.32.
The updated guidance implies revenue growth of 25% year over year, with adjusted EPS up 26%. Those are still great numbers, but CEO Calvin McDonald called out the omicron variant and other disruptions that are slowing momentum.
"We started the holiday season in a strong position but have since experienced several consequences of the Omicron variant, including increased capacity constraints, more limited staff availability, and reduced operating hours in certain locations."
But these are the least of Mr. Market's problems. The stock market has fallen in recent weeks over inflationary headwinds in the economy, and the potential that the Federal Reserve will raise interest rates to put a halt to escalating consumer prices.
Is Lululemon too expensive?
In November, Lululemon shares traded at a forward price-to-earnings (P/E) ratio of 60 based on earnings estimates for fiscal 2021. Taking the inverse of that ratio gives an earnings yield of 1.66%, which is slightly below the current 10-year U.S. Treasury bond rate of 1.85%. But with treasury rates trending higher, investors also require a higher earnings yield, which explains why Lululemon and other high-P/E growth stocks have dropped to start the year.
LULU PE Ratio (Forward) data by YCharts
This explains the near-term volatility with Lululemon's stock price, but it's no reason to sell if you are investing for the long term. After all, interest rates have gone through cycles for decades, but that didn't force billionaire Warren Buffett to trade in and out of Berkshire Hathaway.
A good business will continue investing to increase its intrinsic value no matter what's going on with the economy or interest rates. "We are still in the early innings of our growth, fueled by exciting innovations that create even more opportunity into the future," McDonald noted in March 2021.
Keep your eyes on the prize
Lululemon is generating just under $6 billion in trailing-12-month revenue and is operating in a growing $366 billion activewear industry. The industry is expected to reach $439 billion by 2026, according to Statista. This is a large enough market that justifies a high valuation for Lululemon, but worrying about the "right P/E" for the stock is a mistake.
Consider Nike. In 1991, the swoosh traded at a P/E of 60 -- the same as Lululemon recently -- and generated $3.2 billion in revenue. A $10,000 investment in Nike at "overvalued" levels would have turned into $624,000 today.
I believe Lululemon is on track to deliver similar returns, and the pace at which it is growing revenue verifies my confidence. Lululemon is planning to launch its own footwear line this year, which could be a huge sales driver. I would look at the recent dip as a buying opportunity.
