What Happened At Green Mountain?
Investors watched in horror as Green Mountain Coffee Roasters (GMCR) shares fell some 39% on November 10th following a slight earnings miss. As it turns out, the earnings miss was only by one penny, with the company reporting earnings of $0.47 compared to an expected $0.48. Despite this fact, the stock tanked. Many attribute the dramatic fall to a combination of factors including a negative report from a legendary short seller, and an overpriced stock in general. GMCR had been trading at 36 times earnings in early October, which eased down to 26 times earnings on November 9th, the day before the fall. Twenty-six to thirty-six times earnings is just too much of a premium to pay for just about any company in this market. The market had priced in too high of a premium for an expectedly high growth rate that appears to finally be slowing. With this fall, many investors have been looking around for the next high PE stock to take a tumble.
Red Flags At Lululemon
Investors looking for this type of stock should be paying attention to Lululemon (LULU). This apparel company, which currently trades at $49 a share, has a number of red flags concerning its future. The first problem is the fact that Lululemon has a price to earnings ratio of 42.6 at the moment. This is in contrast to a 5 year expected earnings growth rate of 27.5 percent. Most consider fair value to pay for a stock to be equal to its 5 year expected growth rate. Using that system, LULU would currently be at fair value with a price of $31.62 a share, a staggering 35% decrease to its current price.
PE ratio alone is not enough to discount Lululemon completely. After all, the company has managed to beat earnings estimates for the last 13 quarters. That being said, it should be noted that the earnings surprises have been decreasing in size. There are other reasons that LULU should be dumped though.
In September alone, an officer and major holder of LULU stock directly sold off 100,000 shares. That September seller began the selling at $55 a share for Lululemon (the stock now trades at $49). Other insiders have also been dumping their shares, and few if any are picking up shares at these levels.
Finally, there are 470,000 more shares short as of October 31st than there were on September 30th.
A Look Ahead
Lululemon is expected to release earnings on December 1st. Many are still expecting that they will beat earnings estimates, and that may very well happen. The catalyst that brings LULU shares down may not be the earnings release at all, but perhaps the outlook. If LULU suggests that growth could slow down at all, then shares may begin to collapse. A 5 year growth rate of 27.5 percent is very optimistic in this economic environment, and that may well get changed. Even at that fast paced rate, the shares are still pricing in a much higher rate of growth.
Lululemon is in the business of apparel, and trends in this space change often. Giving such a high multiple to this kind of stock is probably not the best idea. Those looking for a short play may well consider getting short LULU before the earnings report on December 1st. Be prepared for potential risk though. If the company reports another earnings beat and maintains its growth outlook, then this much hyped stock could climb to even more ridiculous levels.