Up 54% in the past 12 months, what’s next for Lululemon Athletica (NASDAQ:LULU) stock? That’s a good question.
On one hand, momentum still seems to be on the side of the athleisure apparel powerhouse. Covid-19 slowed things down a bit growth-wise in 2020. But analysts project 25% revenue growth, and 46% earnings growth, in the coming fiscal year (ending January 2022).
On the other hand, even with the aforementioned growth/recovery story, shares remain way ahead of themselves valuation-wise. Trading for a forward price-earnings ratio of 77.2x, Lululemon trades more like a tech stock than an apparel stock. So far, valuation concerns haven’t negatively affected share performance.
This has been the case for several years. LULU stock is up 540% since 2016. But, while it’s been a stock market winner several years in a row, things could change in 2021. Why? The stock trades at a growth premium far above where it was before the outbreak.
With shares priced for perfection, any hiccup in the coming year could be enough to send shares falling back towards prior price levels. Admittedly, given how the bubble in home gym plays continues, going short may be just as risky as going long at today’s prices. Potential gains from going short are not that great, when you consider continued enthusiasm could send share to an even more unsustainable valuation.
So, with this in mind, what’s the call? Not worth it as a buy, and too risky to short, the best move is to hold off for now.
LULU Stock and the Bubble in Home Gym Stocks
Given how well home gym plays like Peloton (NASDAQ:PTON) have performed since the pandemic, it makes sense names like Lululemon remain popular among investors as well. And, while you may think this company is more like Nike (NYSE:NKE) than Peloton, think again.
As InvestorPlace’s Dana Blankenhorn discussed Dec. 9, with the company’s purchase of fitness streaming device maker Mirror, it could become a formidable rival to the interactive fitness products maker.
Yet while it’s a possibility, don’t let your imagination get ahead of yourself. It remains to be seen whether Mirror, which is expected to have $150 million in revenue this fiscal year, will reach Peloton levels of success. The larger issue at hand is whether its rate of growth can sustain today’s share price (around $370 per share).
As I mentioned above, valuation is stretched at today’s forward P/E. Sure, investors anticipate higher-than-expected growth over the next few years. That’s not to say shares will fall tremendously if things fall short of expectation. But, even if high growth continues, valuation could contract, potentially pushing shares 35% below today’s prices.
Potential Downside if Valuation Contracts in 2021
Right now, investors are willing to pay top dollar for this stock. Given home fitness is growing rapidly thanks to Covid-19, investors anticipate higher-than-expected growth. As this Seeking Alpha commentator noted, LULU stock is priced as if the company will grow 35% per year over the next five years. Projecting growth through 2026 will come in at just 20% per year instead, the commentator sees shares having a fair value more than 53% below current prices.
Is it possible shares dive towards this price level in the near term? If sales/earnings growth falls short of the aforementioned high expectations, I can see a correction happening. But, not to as extreme a degree as a 50%-plus drop.
During the height of the “coronavirus crash,” Lululemon shares hit prices well below this bearish target. Outside of another market-wide crash, I don’t see shares halving anytime soon.
But what I can see is shares giving up a large chunk of their post-pandemic gains, settling back below $250 per share. Before taking off in 2018, shares traded for a P/E ratio of around 30x-40x. Based on sell-side projections for FY 2022 of $6.72 per share, that means a share price of between $201.60 and $268.80 per share. Splitting the difference, that gives us a price target of around $235 per share.
In other words, around 35% potential downside risk. Given that shares have little potential runway to counter this big downside risk, buying today doesn’t look like a worthwhile move.
Lululemon Correction Not Inevitable, But Watch Out!
While I sound bearish on this stock’s near-term prospects, don’t take this to mean it’s time to go short. If the current bubble in home fitness stocks continues, valuation could get even more stretched. Given my estimate for maximum potential downside is 35%, the potential gain from a short position may fail to exceed to the risk of another out-of-nowhere rally.
Yet, while it’s too risky to go short, it’s not worth it to go long LULU stock at today’s prices. With the share price way ahead of itself (even when accounting for growth), risk/return is clearly not in your favor here.
On the date of publication, Thomas Niel did not (either directly or indirectly) hold any positions in the securities mentioned in this article.
Thomas Niel, a contributor to InvestorPlace, has written single-stock analysis columns since 2016.