Lululemon: The problem is with the valuation

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For all the fretting over the details of Lululemon Athletica Inc.'s latest quarterly projections, the real problem with the stock boils down to one simple fact: It's expensive.

On Tuesday morning, the shares took a nasty 7 per cent tumble – their biggest dip in six months – after Lululemon reported what looked like an okay quarter ahead. The yoga-wear retailer said earnings would rise to 74 cents (U.S.) a share in the fiscal fourth quarter, slightly ahead of earlier guidance and in line with analysts' expectations.

The stumble came from sales expectations, but only when compared to analysts' forecasts. The company estimates that sales will range between $475-million and $480-million. That is at the high end of its earlier forecast, but slightly below analysts' expectations for sales of $489-million.

That might not sound like a big deal. But what's worrying investors is that comparable store sales (that is, stores open for at least a year) had been growing by double digits over the past 13 consecutive quarters. The latest projection would break that streak, with growth in the high single-digits.

For anyone enthusiastic about the investment potential of high-end yoga-wear, this doesn't look like much to worry about.

"We'd consider a stock pullback as a particularly attractive buying opportunity," said Roxanne Meyer, an analyst at UBS, in a note, adding that the top and bottom-line results are a "standout."

Camilo Lyon at Canaccord Genuity also remains enthusiastic, based partly on the belief that "demand for the brand has not ebbed whatsoever."

So if things look so good for Lululemon, why all the sour faces in the stock market? The reason boils down to lofty expectations built into the share price, after a 59 per cent return in 2012.

The price-to-book ratio is nearly 10 and the price-to-sales ratio is nearly 8, both of which imply big things ahead – or else. The shares also trade at more than 42-times trailing earnings and 37-times estimated earnings – also implying nothing but smooth growth that tops expectations.

Lululemon has a proven track record for brand loyalty, company expansion and earnings growth. But Tuesday's setback in the stock market also proves that expectations have moved too high.