Seeking out businesses that increase their sales and profits at a rapid clip is an appealing investment strategy that could help to achieve stock market outperformance over the long term. The thinking is that if a company is able to boost its top and bottom lines, then it must be out-competing rivals in its industry -- clearly a positive sign -- and investors will come to appreciate the stock more.
Lululemon Athletica (LULU 0.04%) is a great example. The popular athleisure company continues thriving in what has been a difficult macroeconomic environment. Here's why it's my top growth stock to buy now.
Inventory buildup
Lululemon recently reported its fiscal 2022 third quarter financial results with revenue of $1.9 billion (up 28% year over year) and net income of $255.5 million (up 36%) both exceeding Wall Street estimates. Same-store sales, which look at revenue from locations that have been open for at least 12 months, jumped 22% compared to Q3 2021.
What's more, Lululemon opened 23 net new stores in the period, bringing the total to 623. That's about a 4% expansion of the company's physical footprint in just one fiscal quarter, a remarkable feat when you consider that many enterprises today are pulling back on capital expenditures with the expectation of a recession on the horizon. Lululemon is still in full-on growth mode, which is something investors should be happy to see.
These positive Q3 numbers suggest that the business is firing on all cylinders right now. However, the market is a forward-looking machine. And because of this, Lululemon's shares dropped more than 7% immediately after the earnings release.
Why such a pessimistic tone? For starters, management provided weaker-than-expected fourth-quarter guidance, calling for revenue to come in at $2.63 billion and earnings per share (EPS) to be $4.25 (both at the midpoint). Consensus expectations were for revenue of $2.65 billion and EPS of $4.30, so Lululemon's slight misses disappointed what Wall Street wanted.
What's more -- and what I think really took shareholders by surprise -- was the fact that inventory soared 85% year over year to a balance of $1.7 billion as of Oct. 30. "Inventory levels were too lean last year, and we made the strategic decision to build inventories this year, which enabled the strong top-line growth we have delivered," CEO Calvin McDonald highlighted on the Q3 2022 earnings call.
The good news is that this inventory pile-up isn't specific to Lululemon. Bigger rival Nike saw its inventory balance jump 44% in its latest fiscal quarter (ended Aug. 31). Nonetheless, investors are worried that Lululemon will have to resort to discounts and other promotional activities to push its high-priced merchandise, a strategy the business hasn't traditionally had to pursue. McDonald did mention that Lululemon has been able to sell its products at regular price.
Still a booming business
Despite the stock's negative reaction following Lululemon's latest financial release, it was still an extremely positive quarter. And the leadership team remains incredibly optimistic about the business. They raised revenue and earnings guidance for the current quarter as well as for the fiscal year, based on how strong the holiday shopping season is going thus far.
Management thinks Lululemon will post revenue of $7.97 billion for the full year, which would be a 27.4% rise versus 2021. And adjusted EPS is expected to come in at $9.92, up 27.3% year over year. These are remarkable rates of growth given the economic uncertainty today.
Lululemon's long-term picture also remains as strong as ever. The company's "Power of Three x2" financial outlook, announced in April, sees the business hitting $12.5 billion in annual revenue in fiscal 2026, double 2021's total. Doubling both men's and digital sales, and quadrupling international revenue, are key pillars of this growth strategy.
While investors shouldn't necessarily accept any management team's financial targets as gospel, I would actually be surprised if Lululemon didn't meet its goals. The company is continuing to flourish in what has been a tumultuous operating environment over the past few years, with the coronavirus pandemic and now soaring inflation and a potential recession. Despite these headwinds, Lululemon keeps registering outstanding gains. This gives me tremendous confidence as we look ahead.
With the shares down more than 10% over the past week and 15% in 2022, the stock currently trades at a price-to-earnings ratio of 36, which is significantly below the trailing five-year average of 54. Investors should take a closer look at buying Lululemon now on the pullback.
