Typically, when companies forecast lower sales or profits, their stocks usually take a hit. It's not always easy to tell whether it's having a fire sale or burning down its house. Maybe it is time to get out -- or maybe it's time to buy more!
For yoga and athletic-wear maker lululemon athletica (NASDAQ:LULU), after trouncing analyst expectations in the third quarter, it offered up earnings guidance of $0.71 to $0.73 a share, below Wall Street's $0.75 forecasts, and the markets reacted accordingly. Yet I think management is playing a game with the markets, purposely lowballing its guidance so as to beat them later on. It's a pattern that's been repeating all year long, and the regularity of its occurrence reminds me of how during the tech boom of the '90s, Cisco (NASDAQ:CSCO) managed to consistently meet or beat analyst expectations without fail every single quarter -- in fact, it did it for a stretch of 43 consecutive quarters!
Now don't blindly follow those selling (or buying) on this apparent bearish signal: You still need to do some research. We'll just use the announcement as a jumping-off point for additional research.
Like lemmings over the cliff
With all the bears that do surround Lululemon, it doesn't have to worry the analyst community will get too aggressive and start raising its estimates higher so that actual earnings will end up just matching, or, worse, falling short of expectations. Right now it's able to manage them enough that it can continue moving its stock higher.
And move higher it has. Shares trade almost 60% above where they started 2012 despite concerns about inventories and profits early on. But it's a dangerous game, because a company shouldn't focus so much on what Wall Street thinks but rather how well its business is running. Grow sales and profits, and the stock will take care of itself.
Right now, Lululemon's business is going well. Revenues jumped 37% last quarter as same-store sales rose 8% over the year-ago period while direct-to-consumer revenue surged 89%. Over the past three years it has grown sales at a 47% annualized clip, while profits are up an amazing 79% in that same period. Compare that with Under Armour (NYSE:UAA) at 33% and 35%, respectively, or even the vaunted Nike (NYSE:NKE) at 11% and 12%, respectively.
An unraveling thread
The space is getting more crowded, though, with additional entrants such as Gap (NYSE:GPS), which introduced its own Athleta line, PVH (NYSE:PVH), G-III Apparel (NASDAQ:GIII), and other trendy designers. That played a role in investor worries about the apparent fall-off in revenue guidance for the coming quarter as it may pressure margins, but others may want to see it as an opportunity: If the competition is filling up the space, then the space may be expanding so much that no longer is yoga wear a fad but a real retail trend.
I'm not certain yoga clothes aren't a fad, and the drop in expectations indicates consumers aren't willing to continue paying top prices, particularly when there are a lot of options now. When Lululemon was really the only game in town it was a different story, and though small rivals like Canadian upstart Lole won't be much of a threat, as Nike, Under Armour, and Gap expand their lines that won't continue to be the case.
This could be the first cracks in the foundation that its gamesmanship in earnings management won't be able to cover. At 46 times trailing earnings and 32 times estimates, it's starting to look like it will need to catch up to expectations to become a value, and that means the stock is going to have to come down even more. Noted hedge fund operator and short seller David Einhorn may not be shorting lululemon athletica's stock just yet, but that doesn't mean you have to be a buyer.
Rich Duprey owns shares of Cisco Systems and Nike. The Motley Fool owns shares of Nike and Under Armour. Motley Fool newsletter services recommend Cisco Systems, lululemon athletica, Nike, and Under Armour. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.