One of Wall Street's biggest winners of the day is Lululemon Athletica Inc., which announced a 29% year on year sales increase and higher than expected net earnings. Shares of the apparel retail jumped 6.6% to a price of $313.85 -- its biggest price hump in 10 years. It now sits 17.16% below its average analyst target price of $378.85 and has an average rating of buy. LULU may have outstripped the S&P 500 index by 7.2% so far today, but it has lagged behind the index by 11.6% over the last year, returning -24.2%.
Lululemon is categorized within the consumer cyclical sector, which encompasses the luxury goods, clothing, travel, and entertainment industries. The cyclical aspect of these companies refers to the tendency of their sales -- and as a result, their stock price -- to correlate with periods of economic expansion and contraction.
The reason behind this is that when the economy is growing, the average consumer has more money to spend on the discretionary (non necessary) products that cyclical consumer companies tend to offer. Consumer cyclical stocks may offer more growth potential than non-cyclical or defensive stocks, but at the expense of higher volatility.
As of the second quarter of 2022, the average Price to Earnings (P/E) ratio for US consumer cyclical companies is 24.27, and the S&P 500 has an average of 15.97. The P/E ratio consists in the stock's share price divided by its earnings per share (Eps), representing how much investors are willing to spend for each dollar of the company's earnings. Earnings are the company's revenues minus the cost of goods sold, overhead, and taxes.
Lululemon's trailing 12 month P/E ratio is 40.7, based on its trailing Eps of $7.72. The company has a forward P/E ratio of 28.4 according to its forward Eps of $11.05 -- which is an estimate of what its earnings will look like in the next quarter. Even with the brighter earnings outlook, the stock's forward P/E ratio remains elevated.
Earnings are the most widely used metric for understanding a stock's valuation. When considered alongside the company's revenue growth, they can also give insight into the company's margins, which in turn can allow us to make inferences about its possible competitive advantages. Lululemon's year on year (YOY) earnings and revenues for the second quarter grew at a rate of 42.1% and 28.8% respectively.
Since the earnings growth rate is higher than the revenue growth rate, we can deduce that the company's profit margins are widening. Companies can increase their earnings at a faster rate than their revenue by reducing their tax liability, raising prices, or cutting their overhead or the cost of goods sold.
Unlike earnings, gross profits only take into account the company's cost of goods sold (i.e. cost of labor and materials only). The extent of gross profit margins implies how much freedom the company has in setting the prices of its products. A wider gross profit margin indicates that a company may have a competitive advantage, as it is free to keep its product prices high relative to their cost. In LULU's case, gross profit margins are 56.5%, which indicates that it potentially benefits from a sustained competitive advantage over its peers, allowing it to maintain highly profitable pricing structures.
Companies have many other costs and sources of income occurring outside of their core business. Everything from equipment depreciation, returns on capital investments, legal costs, income from intellectual property, and interest payments on debt factor into the company's ultimate profitability. We can see the effect of these additional factors in lululemon athletica inc.'s levered free cash flow of $165,685,632.
This represents the amount of money that is available for reinvesting in the business, or paying out to investors in the form of a dividend. With a positive cash flow, LULU is in a position to do either -- which can encourage more investors to place their capital in the company.
Value investors often analyze stocks through the lens of its Price to Book (P/B) Ratio (its share price divided by its book value). The book value refers to the present value of the company if the company were to sell off all of its assets and pay all of its debts today - a number whose value may differ significantly depending on the accounting method.
Lululemon athletica inc.'s P/B ratio indicates that the market value of the company exceeds its book value by a factor of 14, so the company's assets may be overvalued compared to the average P/B ratio of the Consumer Cyclical sector, which stands at 3.23 as of the second quarter of 2022.
LULU may have excellent profit margins, strong cash flows, and an analyst consensus of some upside potential, but its inflated P/E and P/B ratios show that the company is likely fairly valued at today's prices. We hope you enjoyed this overview of LULU's fundamentals. Before you reach your own decision, be sure to check the numbers for yourself, especially focusing on their trends over the last few years.
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