Lululemon Athletica (LULU -5.54%) investors enjoyed a mostly uninterrupted upward trajectory in its stock price from 2018 till the end of 2021. But supply chain challenges and inflation threw a wrench into that narrative in 2022 and 2023. Still, by the end of last year, Lululemon had broken above $515 a share to make a fresh, all-time high.

Now, the athleisure brand is experiencing a brutal downturn once again. The stock is down over 41% year to date, vaporizing around $25 billion in market capitalization. The sell-off accelerated on May 22 on news that Lululemon's  chief product officer was leaving the company. Unexpected upper-management departures during a fragile period can test already strained investor confidence.

As the time of this writing, Lululemon is the worst-performing S&P 500 component and the second-worst-performing Nasdaq-100 component in 2024. The Nasdaq-100 is the 100 largest non-financial companies in the Nasdaq Composite.

Despite all of the challenges, here's why Lululemon remains a top growth stock to buy on the dip.

A person wearing athletic attire smiles while holding a water bottle and sitting on a park bench.

Image source: Getty Images.

Lululemon is not alone

Lululemon is part of the consumer-discretionary sector which includes automakers, a variety of retail, e-commerce, restaurant, hotel and travel companies, and more. Due to its growth-oriented nature and size, the sector tends to be one of the leaders during bull markets. But that hasn't been the case this year.

XLC Chart

XLC data by YCharts.

Amazon is the largest holding in the Consumer Discretionary Select Sector SPDR Fund (XLY -0.07%) and has been a rare winner in an otherwise poorly performing sector. Factoring out its roughly 24% weighting and 20% year-to-date gain, the sector would be down around five percentage points more on the year.

Consumers are feeling the impact of high interest rates and are cutting back spending where they can. Curbing discretionary purchases on goods and vacations is easier than pulling back on staples, utilities, or energy.

Home Depot and Lowe's just reported slowing growth and muted expectations for 2024. Lululemon competitor Nike is facing low growth and mounting competition. Its stock price is hovering around a three-year low. Tesla has rebounded in recent weeks but is still down over 27% year to date due to weak demand and higher competition.

Seemingly, every industry in the consumer-discretionary sector is experiencing some combination of higher competition, weak demand, and eroding pricing power. In an economic expansion, demand tends to be strong, which helps justify pricing power. The issue with the present market rally is that it is mostly led by business-to-business companies, not business-to-consumer. Think Nvidia selling chips to Meta Platforms, industrial conglomerates with business customers, etc.

The slowdown across the consumer-discretionary sector is a noticeable crack in the bull market. The following chart illustrates a major headwind for the sector's turnaround.

US Credit Card Debt Chart

US Credit Card Debt data by YCharts.

Pre-pandemic, U.S. credit card debt was approaching the $1 trillion mark. However, consumers did an excellent job of paying down credit card balances in 2020 and 2021. However, the trend has reversed, and credit card debt is now at an all-time high.

The U.S. fixed housing-affordability index considers housing prices and mortgage interest rates to measure home affordability. In this sense, it's a better indicator than solely looking at average home prices or interest rates.

According to the Federal Reserve Bank of St. Louis, "An index above 100 signifies that a family earning the median income has more than enough income to qualify for a mortgage loan on a median-priced home, assuming a 20 percent down payment." The index is hovering around 100, meaning that a good portion of families earning median income can't afford a home.

Lululemon's growth is projected to slow

Macroeconomic factors and consumer-behavior trends matter greatly to Lululemon, especially when it is undergoing rapid expansion. Weaker demand means lower volume growth and less pricing power, which is the opposite of what Lululemon has enjoyed in recent years.

Up until now, Lululemon's stock price, sales, and operating margins have looked like a rocket ship. Pre-pandemic, the company had never earned more than $4 billion in sales for a 12-month period. Today, it is knocking on the door of $10 billion in sales while operating margins are at a 10-year high of 23%.

LULU Chart

LULU data by YCharts.

For context, Nike's trailing-12-month operating margin is 11.6% and has never been over 20% in the last 30 years. A 23% operating margin is extremely high for this type of business. Given the high profitability and sales growth, it's understandable why investors piled into Lululemon and drove the stock price higher.

When expectations are lofty, a stock can be priced to perfection, which leaves it vulnerable to a sell-off. Management's commentary on the late-March earnings call acknowledged the slow start to the calendar year and consumer challenges, but the company still expected to take market share and grow in 2024.

Lululemon's current price-to-earnings (P/E) ratio is 24.6, and its forward P/E is 21.1, while its price-to-sales (P/S) ratio is 4, and its forward P/S ratio is 3.5 -- meaning estimates are calling for mid-teens growth in sales and earnings. This is a noticeable step down from Lululemon's prior-growth rate, but it isn't too bad, given the circumstances. But if the situation worsens, analysts could revise their estimates, which would make the stock look more expensive.

Keep it simple with Lululemon

The consumer-discretionary sector is highly cyclical and subject to steep downturns. However, it is one of the sectors where brands matter -- a lot. The best ones can take market share during a slowdown in the business cycle. So far, Lululemon has shown very few signs of a deteriorating brand and is still expected to grow this year.

However, the departure of a top executive is a bad look. We'll have to wait until June 5 to hear from Lululemon on its Q1 2024 earnings call. The most important factors to watch are management's commentary on the strength of the consumer and new guidance for the year.

It's unlikely Lululemon would ever admit its brand is losing its luster. A good way to measure a brand's strength is to see how it is performing relative to peers. If Lululemon's growth slows but is still good compared to Nike, Adidas, and other competitors, that would indicate an overall downturn (not brand weakness) is driving poor results.

Lululemon stock deserved to sell off, but its valuation is starting to look very attractive. The stock could fall more if the near-term outlook looks weak, but this is a great opportunity for long-term investors to pick up shares of a top brand while it is out of favor.