Is the growth worth it?
While often misquoted to imply that identifying a strong company that an investor understands is the end of an investors’ homework prior to buying shares, Lynch is adamant that an understanding of earnings and valuation is a prerequisite to any purchase. As this applies to Under Armour and Lululemon, this is where the decision gets complicated; both companies are trading at a clear premium to their apparel peers:
| NKE | UA | LULU | COLM | |
|---|---|---|---|---|
| TTM revenue (in billions) | $25.3 | $2.0 | $1.5 | $1.7 |
| TTM price to sales ratio | 2.4 | 4.1 | 6.6 | 1.2 |
| TTM price to earnings ratio | 25.1 | 60.6 | 37.9 | 19.0 |
| Forward price to earnings ratio | 19.7 | 41.0 | 27.9 | 18.9 |
| PEG ratio | 1.9 | 2.6 | 1.8 | 2.7 |
| Debt to equity ratio | 0.12 | 0.06 | 0.00 | 0.00 |
| Free cash flow yield | 4.1% | 0.8% | 1.9% | 5.3% |
| Dividend yield | 1.3% | 0% | 0% | 1.5% |
| Source: Yahoo! Finance 9/16/13 |
Based on the metrics in the table above, a decent argument can be made that all four of these companies are overpriced based on future growth projections. While this may be an indication that today is not the best time to buy stock in these companies, it doesn’t mean that strong growth companies like Under Armour and Lululemon shouldn’t remain on an investor’s radar.
Consider this: if Under Armour and Lululemon were to reach the long-term revenue targets of $10 billion and $12 billion ($1.5 billion times 8), respectively, and assuming that NIKE, Inc. (NYSE:NKE)’s current price to sales ratio of 2.4 represents a reasonable valuation multiple, the future market capitalizations for Under Armour and Lululemon would be $24 billion and $29 billion, respectively. For reference, this would translate into increases of 200% and 180% for investors from today’s “expensive” share prices; while this outcome may take a decade to materialize, these projections translate into a very reasonable 11%-12% annualized return if 10 years is considered a reasonable timeline to achieve this growth.
What to do now?
Thus far, it has been established that Under Armour and Lululemon both remain strong growth stories. While it is difficult to argue that the shares of either company are cheap today, there is still potential for long-term investors to earn solid returns buying at today’s prices.
So what is the next step for investors that like the companies but are weary of the price? Waiting for better value points is certainly a reasonable strategy. Both Under Armour and Lululemon have presented investors with numerous opportunities to invest with a forward price to earnings ratio of 25 or less as illustrated by this chart:
UA P/E Ratio TTM data by YCharts
Investors will have this opportunity again in the future. This shouldn’t be a groundbreaking prediction given the volatility associated with high-growth companies like Under Armour and Lululemon. An earnings miss, negative news, or an analyst downgrade can have a dramatic effect on these companies. Lululemon’s string of bad news regarding product quality issues and the departure of its former CEO earlier this year dropped the company’s share price around $20 from its high of $82.50. For investors with a long-term perspective and belief that the negative information is short term in nature, such volatility presents investors with a fantastic opportunity to start (or add to) a position in either of these companies.
The article Buy What You Know… At the Right Price originally appeared on Fool.com and is written by Brian Shaw.
Brian Shaw owns shares of Under Armour. The Motley Fool recommends Lululemon Athletica, Nike, and Under Armour. The Motley Fool owns shares of Nike and Under Armour.
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