Investors were cautiously optimistic heading into the fourth-quarter earnings report from lululemon athletica (NASDAQ:LULU). While they expected strong sales growth to close out fiscal 2020, shareholders were worried about rising costs and inventory pressures that might have slowed profit gains. The yoga apparel specialist’s stock also followed Nike (NYSE:NKE) lower after the footwear giant posted weak holiday season revenue.
Lululemon’s Q4 results, released on March 30, settled most of those questions in a positive light. As a result, investors have some good reasons to buy this stock even if it looks expensive compared to Nike and other peers.
Lululemon is producing market-beating growth
Owning Lululemon stock gives an investor a level of growth that’s hard to find on the market. The company’s Q4 results showed off that performance, as sales jumped 24% thanks to booming demand in the e-commerce channel.
Nike is capitalizing on the same favorable demand trends for athleisure wear, but its expansion pace is weaker. Nike sales are up 4% over the past nine months, while Lululemon’s revenue rose 11% in the fiscal year that ended in early February. That double-digit spike looks more impressive when you consider that it happened through several weeks of retailing closures followed by months of restricted customer traffic at its stores.
The outlook is even brighter, with sales likely to rise over 20% in 2021 to $5.6 billion, according to management’s latest forecast. Nike is predicting gains at about half that rate for its current fiscal year.
Lululemon has a profit margin advantage
Nike is also forecasting that profit margins will rise steadily over the next few years as more of its business shifts toward direct-to-consumer sales. But you can buy Lululemon and instantly get the benefit of that industry trend. Its digital business accounted for more than half of all sales this past quarter, which lifted gross margin to nearly 60%.
Most of those gains trickled down to the bottom line, too. Despite extra spending on the e-commerce platform and COVID-19-related expenses, Lululemon’s operating margin is still near 20% of sales — a rate that Nike hasn’t approached in years.
Weighing Lululemon’s stock price and value
You’ll have to pay a premium to own such a high-performing business. As of early April, investors are paying over 9 times sales for Lululemon’s stock compared to 5.6 times sales for Nike. The stock is expensive on a price-to-earnings basis, too, at 68 versus Nike’s 63.
The good news is that those valuations have dropped over the past six months or so as Lululemon got caught up in the wider drawdown among growth stocks. While there’s no mixing it up for a value stock today, a valuation of 9 times sales is cheaper than the nearly 13 times sales investors were paying in late 2020. And Lululemon’s business has only strengthened since then.
The company faces some major risks: Its $4.4 billion annual sales footprint is tiny compared to Nike’s almost $40 billion yearly haul. That leaves the company exposed to a sales slump if consumer demand shifts away from its main niches. Lululemon also entered 2021 with elevated inventory holdings that might portend weaker profitability.
Still, if you’re looking for an attractive growth stock with a good shot at achieving much-higher sales and earnings over the next decade, Lululemon fits right into that growth investing narrative.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.