Yahoo Finance Is Lululemon Athletica Inc’s (NASDAQ:LULU) PE Ratio A Signal To Sell For Investors?
The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning the link between Lululemon Athletica Inc (NASDAQ:LULU)’s fundamentals and stock market performance.
Lululemon Athletica Inc (NASDAQ:LULU) is currently trading at a trailing P/E of 56x, which is higher than the industry average of 24.6x. While this makes LULU appear like a stock to avoid or sell if you own it, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. View out our latest analysis for Lululemon Athletica
Breaking down the Price-Earnings ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for LULU
Price-Earnings Ratio = Price per share ÷ Earnings per share
LULU Price-Earnings Ratio = $124.86 ÷ $2.231 = 56x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to LULU, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. At 56x, LULU’s P/E is higher than its industry peers (24.6x). This implies that investors are overvaluing each dollar of LULU’s earnings. Therefore, according to this analysis, LULU is an over-priced stock.
Assumptions to be aware of
While our conclusion might prompt you to sell your LULU shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to LULU. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with LULU, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing LULU to are fairly valued by the market. If this is violated, LULU’s P/E may be lower than its peers as they are actually overvalued by investors.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in LULU. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for LULU’s future growth? Take a look at our free research report of analyst consensus for LULU’s outlook.
Past Track Record: Has LULU been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of LULU’s historicals for more clarity.
Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see pass 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.
