Lululemon Athletica (NASDAQ:LULU) is a cult retail stock. Known among consumers for its chic yoga pants and athletic apparel and known on Wall Street for its 1,000% gains since January 2009, Lululemon is very closely watched.
So it’s no surprise that LULU stock took a beating today after “disappointing” earnings. Lululemon Athletica reported a sales shortfall, and the stock dived as much as 11% in early trading.
Of course, it’s worth noting that Lululemon had a lot of positives in that report. Including:
- Third-quarter earnings per share jumped 50%, from 18 cents last year to 27 cents
- Revenue jumped 31% to $230 million
- Same-store sales were up 16% year-over-year for the quarter.
So how did LULU disappoint? Well, because the bar was so high. Analysts on Wall Street expected sales of $235 million. Also, the 16% same-store-sales growth was below last quarter’s 20% clip.
That’s the trouble with a momentum stock like Lululemon — the bar keeps getting raised higher and higher as crazed investors flock to the stock. A well-run company can keep jumping over those high bars repeatedly and fool some into thinking the ride may never end. But make no mistake — eventually, the expectations get to be too high for any stock.
And then the bottom falls out.
If past is precedent, the double-digit slide for LULU today could be only the beginning. Typically, an earnings miss like this is the first warning sign — like one or two cockroaches spotted scurrying around the baseboards. Some investors will ignore them. Others will say “it’s just one or two bugs.” But unfortunately, sometimes the cockroaches you can see are just a small portion of the infestation behind the walls.
Take Netflix (NASDAQ:NFLX). Problems started to pop up long before the the ill-advised Qwikster scheme was unveiled. Netflix admitted in its Q2 earnings on July 25 that it could lose subscribers due pricing changes. The stock was nearly $300 then. Analysts in mid-August hinted that the online video giant could lose millions of subscribers due to a pricing change. The price then was well over $200 a share — down from its peak, but remember that August was brutal for many stocks. Now NFLX is trading around $65 a share.
Then there’s Green Mountain (NASDAQ:GMCR). Shares were over $100 in September on continued success with its Keurig line. Then in October, momentum started to wane. It became public that hedge fund manager David Einhorn was betting against GMCR big-time. To top it off, a no-name coffee company created a killer patent, allowing it to sell pods for the single-brew Keurig coffee machine without going through Green Mountain. Disappointing earnings in November added to the downdraft. The result is GMCR stock at $50 a share currently.
I’m not saying that Lululemon will fall off the face of the planet. It’s profitable and has loyal customers. But investors need to understand that valuations do matter, and that a forward P/E ratio above 30 is usually a sign of unrealistic expectations. Yes, a rare group of companies can continually jump over those high bars.
But when they trip, they fall flat on their face. That’s what LULU stock did today.
Investors who own Lululemon Athletic should take note of the cautionary tale in Netflix and GMCR. Once the cockroaches pop up, it may be wise to make a hasty exit rather than bank on a rebound.
It’s always hard to let go of a stock that’s growing so impressively. But with momentum stocks like NFLX, LULU and GMCR, it’s not about growth or profits — it’s about expectations and how that affects momentum. As long as things are going up, the ride is a lot of fun. But the ride down can be fast and furious, so invest with caution.
Jeff Reeves is the editor of InvestorPlace.com. Write him at firstname.lastname@example.org, follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook. As of this writing, he did not own a position in any of the aforementioned stocks.