Yahoo Finance Did Lululemon Athletica Inc (NASDAQ:LULU) Create Value For Shareholders?
This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning the link between company’s fundamentals and stock market performance.
With an ROE of 26.5%, Lululemon Athletica Inc (NASDAQ:LULU) outpaced its own industry which delivered a less exciting 12.1% over the past year. While the impressive ratio tells us that LULU has made significant profits from little equity capital, ROE doesn’t tell us if LULU has borrowed debt to make this happen. We’ll take a closer look today at factors like financial leverage to determine whether LULU’s ROE is actually sustainable.
View our latest analysis for Lululemon Athletica
Breaking down Return on Equity
Return on Equity (ROE) weighs Lululemon Athletica’s profit against the level of its shareholders’ equity. An ROE of 26.5% implies $0.26 returned on every $1 invested. While a higher ROE is preferred in most cases, there are several other factors we should consider before drawing any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for Lululemon Athletica, which is 8.6%. This means Lululemon Athletica returns enough to cover its own cost of equity, with a buffer of 17.9%. This sustainable practice implies that the company pays less for its capital than what it generates in return. ROE can be dissected into three distinct ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
Dupont Formula
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
Basically, profit margin measures how much of revenue trickles down into earnings which illustrates how efficient the business is with its cost management. Asset turnover shows how much revenue Lululemon Athletica can generate with its current asset base. The most interesting ratio, and reflective of sustainability of its ROE, is financial leverage. Since ROE can be artificially increased through excessive borrowing, we should check Lululemon Athletica’s historic debt-to-equity ratio. Currently the debt-to-equity ratio stands at a low 7.6%, which means its above-average ROE is driven by its ability to grow its profit without a significant debt burden.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Lululemon Athletica exhibits a strong ROE against its peers, as well as sufficient returns to cover its cost of equity. Its high ROE is not likely to be driven by high debt. Therefore, investors may have more confidence in the sustainability of this level of returns going forward. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Lululemon Athletica, there are three fundamental factors you should further examine:
Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Valuation: What is Lululemon Athletica worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether Lululemon Athletica is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Lululemon Athletica? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
