Lululemon’s P/E Ratio Reaches 2017 Levels Time to Buy the Dip?

Price action, especially on the downside, may scare some investors. However, the price chart is only part of the real story. After falling more than 35% from its all-time high, Lululemon Athletica Inc. NASDAQ: LULU looks like a drop that investors might consider today.

The price of a stock is relative, but its price-earnings multiple (P/E) is a more reliable valuation. And Lululemon’s 27.8x multiple brings it back to 2017 levels, despite growing its underlying earnings per share (EPS) by more than four times. Now that Federal Reserve (Fed) Chair Jerome Powell has spooked markets by potentially further delaying interest rate cuts, consumer discretionary space is in retreat.

Over the past 12 months, Lululemon shares have underperformed SPDR fund for selected consumer discretionary sectors NYSEARCA: XLY up to 25%. Despite being one of the biggest brands in the apparel industry, Lululemon is now heavily discounted and has a long way to go to catch up with the pack.

Why the bear face?

Lululemon’s sell-off stemmed from market-wide disappointment, not a company-specific problem.

The Fed had proposed up to four interest rate cuts this year, the first of which could have been made as early as March. According to CME’s FedWatch tool, these potential cuts have been delayed until September 2024.

The market had to settle for the hypothesis of three cuts instead of the initial four proposed at the beginning of the year. Since the consumer discretionary space – and the US consumer – is highly dependent on financing, this disappointment may have caused Lululemon’s collapse. Commercial banks like it Citigroup Inc. NYSE:C AND Bank of America Co. NYSE:BAC have reported mounting losses in their credit card departments as an inflation-choked consumer has had to rely on credit to keep up with living expenses.

Fearing a turning point for consumers, traders may have sought to reduce risk by selling Lululemon shares. However, US consumer confidence is now at a three-year high The Goldman Sachs Group Inc NYSE:GS The quarterly report shows that interest rate cuts could be just around the corner.

Lululemon continues to dominate the market

Investors can gauge market sentiment toward Lululemon stock while keeping its recent decline out of the equation. To do this, you need to consider two things: earnings per share (EPS) projections and how these future earnings are valued today.

Compared to the broader apparel industry, Lululemon is a standout stock. But instead of looking at all the names, why not stick to the best thing: Nike Inc. NYSE: DI. Nike analysts believe the company could achieve 6% EPS growth over the next 12 months, and markets have slapped a forward P/E multiple of 23.6x on these projections. A P/E of 23.6x is 123% higher than the average apparel sector valuation of 10.6x forward P/E.

Every value investor knows that it’s okay to pay a premium valuation for a stock that carries a stronger brand or product moat, requirements that Nike and Lululemon meet.

This is where it gets interesting. Lululemon is set to grow its EPS by 12% this year, double Nike’s rate. At the same time, markets value these future earnings at a comparable forward P/E of 21.2x, just 10% lower than Nike’s.

In its latest quarterly earnings report, Lululemon announced annual sales growth of 16% and EPS growth of 20%. Even though the US sees a weaker consumer this year, EPS growth projections of 12% are at the more conservative end of the spectrum. Furthermore, even if markets mispriced these potential rate cuts, Lululemon’s revenue growth came primarily from international sales. A weaker U.S. consumer could be dampened by international momentum to take its place.

For these reasons, analysts see a consensus price target of $485.39 for Lululemon, calling for an upside of up to 43% from today’s prices. As ISM manufacturing PMI data suggests, the apparel sector is far from slowing down. After contracting in November and December 2023, the sector expanded for two consecutive months in January and February 2024.

Knowing that this dip is one of the best potential opportunities today, Vanguard Group increased its position in the stock by 32.3% in the last quarter, bringing its total investment to $4.96 billion.

Before you consider Lululemon Athletica, you’ll want to hear this.

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