Today's beating in lululemon athletica (LULU) is a refresher course in the dangers of investing in momentum favorites. The stock was the absolute darling of the Street, and whenever I warned about the risks, I would get a lecture about the company's almost unlimited store growth opportunities and the importance and sustainability of fashion trends. When I reminded these people that I have seen almost 30 years of hot stocks and trends come and go with eerily similar results, I would get the classic "yeah but" objection and insistence that this company is different. It never is, especially in the retail and apparel space.
Yogi Berra once explained why he no longer dined at a popular restaurant by saying, "Nobody goes there anymore. It's too crowded." It's like that in apparel and retail as well, especially among the red-hot teen, young adult and women's markets. When a store or brand becomes too popular, the trend-setters in the market move on to the next big thing, and eventually everyone else follows them.
Under no circumstances do I want to hold myself out as fashion expert, but I have been around long enough to have seen the rise and fall of dozens of retail stores and clothing trends. Those investors who jumped the hot trends and paid 30x, 40x and even 50x earnings for these stocks got slaughtered when the trend ended.
Everyone thinks that he or she will be the one to spot the trend change, but pretty much everyone is wrong about that. The consultants who study such things usually miss it, and most investors are way behind them. When a popular stock in the retail space begins to falter, there is a tendency to think that it is just a misstep and that the company will recapture the market in short order and that the stock will go higher again. It won't. When a company loses the market, it won't get it back for a long time, if ever. The earnings will fall, the multiple will contract, and you will lose money all the way down until the reality hits you that the market has changed and neither the company or the stock is coming back anytime soon.
When I look at the sector today, I see a lot of companies trading at valuations that simply make no sense. Oxford Industries (OXM), for example, is trading at 36x earnings right now. The company has some great brands, such as Tommy Bahama, Lilly Pulitzer, Lanier Clothes and Ben Sherman, but this company is not going to grow at a fast enough pace to justify this price. The enterprise-value-to-EBITDA ratio of 13 isn't going to attract a buyer who is looking to buy the brands, and the price/earnings-to-growth (PEG) ratio is almost 2.5x. One small mistake and this stock goes on the clearance rack.
So far, I have been wrong about Under Armour (UA) all year, but until recently I had been very wrong about lulelemon athletica and Ulta Salon (ULTA) as well, and both of those have given up a year's worth of momentum gains in a short period of time. My valuations are usually pretty close to correct, but my timing needs a little work.
Under Armour is a fantastic company, and I have friends who swear by its stuff, but 65x earnings is too high a price to pay for almost any company, especially a clothing company. Even the earnings projected by the always highly accurate Wall Street analyst community have the stock trading at almost 50x next year's earnings. The company will not grow fast enough to justify the valuation, and at some point there will be an earnings miss or some other less-than-perfect news that brings the stock back to reality.
Certain fashion trends, brands and stores may be hot for a period of time, and as part of the never-ending cycle, Wall street investors will flock to the stupid price. When reality sets in, the losses can be swift and painful. Even a company such as Under Armour, which I believe is a fabulous business, has no margin of safety at the current price and leaves investors exposed to a real chance of permanent impairment of capital.
The trends in this business change so quickly and permanently that paying more than book value or a single-digit earnings multiple for apparel companies and retailers makes no sense to me at all. These sectors more than any other demand a large margin of safety along with a huge dose of skepticism.