👑One of our platform users raised some interesting points about Lululemon. I decided to take a deeper look.
I look for three things before I make an investment:
💲value
📋high quality of earnings
🌱 growth
They have to all be present for me to make an investment and it doesn't happen often. My experience when it does has been good.
💲Intrinsic Value
My model of choice is the Ohlson Clean Surplus (OCS) model. I prefer it to the discounted cash flow (DCF) model because it doesn't require a lot of difficult-to-make estimates (who knows what a company's cash flow is going to be five years out?!?) Like the DCF, it also provides an intrinsic versus a relative value.
The philosophy behind it might be a bit more obtuse than the DCF, but once you chew on it a bit, you might find it quite palatable. The OCS bases its intrinsic value on the present value of "abnormal earnings" plus the current book value.
What are abnormal earnings?
In accounting, transactions are recorded at historical value and because accounting is conservative, values are written down, but very rarely are they written up (mark to market for securities is the only one I can think of). Accounting also does not record internally generated goodwill.
But, internally generated goodwill is a big deal. Not only is it the source of abnormal earnings, it's the company's moat, its unfair advantage. It is customer lists, secret formulas, brand loyalty, trademarks, patents. It is everything a company develops to make itself valuable and all of that is off-balance sheet, unrecorded and invisible to the naked eye.
The OCS, like an X-ray detecting telescope used to observe black holes in space, reveals the effects or more accurately, the forecasted effects of this goodwill.
When I run this calculation I get an intrinsic value for $LULU of $203.08. At time of calculation, $LULU was trading at $162.33, demonstrating that it is undervalued currently.
📋Quality of Earnings
Earnings are a construct. Like manufacturing, earnings are an output, dependent on the input of sales and expenses, but also dependent on many decisions like depreciation and amortization rates, revenue recognition policies, inventory policies and others.
Because the final earnings number happens so far down the stream, it can also be manipulated. Sometimes the manipulation is fraudulent, but it doesn't have to be. Management might decide to enact an aggressive credit policy to boost sales. There's nothing illegal about that but it might not result in persistent earnings.
There are tools and techniques to test earnings. I use a set of equations which provide a window into the quality of earnings. The equations I use reveal whether earnings are persistent and high quality or are the result of management manipulation. The ultimate output of the equations is a signal. I assign a value of one if the signal is good and zero if its bad.
$LULU scored four good signals out of a possible five. Obviously 5/5 would be better, but 4/5 is still acceptable to me. Less than that, no.
🌱Growth
Growth and value are usually given as opposite poles in spectrum. You have value companies on one end and you have growth companies on the other. Low P/E ratios and high p/e ratios respectively.
But I think they can occur at the same time. A company can be growing its sales and its earnings and be undervalued. In the case of $LULU its price has declined precipitously, loosing 40% of its value over the past 52 weeks. It's even more over shorter time frames. However, it's grown its revenue by 9% over the past year and its earnings by 20%. That's a combination I like to see.
Conclusion
This analysis doesn't look at competitive forces or the economic outlook. It didn't parse Calvin McDonald's most recent earnings call. I like numbers and I'm an accountant, so that's what I use. I think there's value in playing to one's strengths. As investors, we only have so much time and I personally like breadth versus depth when it comes to analysis, because I want to find the diamond in the rough and to do that, you need to sift through a large number of companies, or you have to have interesting opportunities brought to your attention by the users of this platform 💖.
For me, $LULU is a buy.