Shares of Lululemon (NASDAQ:LULU) are finally starting to stall after a major move higher. Lululemon stock had rallied over 17% from the early November lows before finally running into resistance.
The company has unquestionably experienced impressive growth over the past several years. The question now is whether that growth can continue at the same pace. This is especially true as both valuations and market cap are at extremes.
LULU stock has had a lulu of a rally. Time to exercise some caution and look for a pullback over the coming months.
LULU Stock Valuation
Click to EnlargeLululemon is certainly getting stretched from a valuation perspective. LULU stock now carries the highest P/E multiple of the year with a reading over 50.
The previous time Lululemon stock was at such lofty levels marked a significant top in the stock. Price/Sales (P/S) is now over eight and at the highest levels ever. Other traditional metrics, such as Price/Cash Flow and Price/Book, are also at extremes.
Lululemon Stock Chart
LULU stock is looking tired from a technical take. 9-day RSI reached extremely overbought levels before weakening considerably. MACD remains tepid even given the recent rally. Momentum is deteriorating quickly with a series of lower highs and is poised to go negative. Lululemon stock is trading at a huge premium to the 100-day moving average which has been a precursor to a pullback in the past.
Most importantly, LULU stock once again failed to break out above the $233 resistance level. The price action on Friday points to a reversal day. Shares opened higher and near the highs of the day just below $233 only to reverse course.
LULU stock closed near the lows, and lower on the day, at $230.02. This type of price action is many times indicative of a short-term top in the stock. The buyers have become exhausted and the sellers are in control. It is especially meaningful following such a strong rally.
The historically rich multiples will be a serious headwind for any further move higher in Lululemon stock. It is difficult to imagine either the P/E or P/S ratio expanding appreciably further from current extremes. More likely, these valuations will revert back to the mean and LULU stock will drop from present levels. Especially given that Lululemon is up over 90% year-to-date. Certainly a bout of profit taking would not be unexpected. This is especially true now that upside momentum has waned considerably.
Stock traders should look to short LULU stock on any meaningful strength. An initial downside target would be the $220 support area. The ultimate downside profit objective would be a reversion back near the 100-day moving average. $250 would be a viable stop out area that mirrors the initial profit objective gain.
Option players may want to use comparatively cheap implied volatility (IV) to position for a pullback with a put debit spread. The January $225/$220 put spread costs around $1.70. The maximum risk on the trade is $170 per spread with a maximum potential gain of $330 if LULU closes below $220 at January expiration. Potential return on risk is 194%.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in receiving finding out more about unusual option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at email@example.com.