03 May 2024

On today’s episode, Clay and Kyle give an overview of their best quality stock idea for Q2 2024. This quarter, they discuss Lululemon.

Lululemon is well-known in the world of quality investors, and the share price has recently declined by over 30%. Tune into today’s episode to hear Clay and Kyle’s thoughts on Lululemon’s business and what the prospective returns might look like going forward.

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  • The competitive advantages of Lululemon.
  • How Lululemon’s margins compare to their competitors.
  • What will drive Lululemon’s future growth.
  • How large Lululemon’s total addressable market is.
  • Our assessment of the management team and balance sheet.
  • Our thoughts on the valuation.
  • Lululemon’s most important key performance indicators.


Disclaimer: The transcript that follows has been generated using artificial intelligence. We strive to be as accurate as possible, but minor errors and slightly off timestamps may be present due to platform differences.

[00:00:00] Clay Finck: On today’s episode, my co-host, Kyle Grieve, and I will be covering our best quality stock idea for Q2, 2024. This is the quarterly series where we share a quality stock that we find to be interesting and worth considering for our own portfolios. Even if you aren’t into individual stocks or not interested in the company we’re covering today, you may find value in hearing our thought process for how we think about analyzing a business.

[00:00:23] Clay Finck: This quarter, we’re going to be covering Lululemon. Lululemon is well known in the world of quality investors, as they have very impressive earnings growth and return on invested capital figures. And the share price has recently declined by over 30%. During this episode, you’ll learn about their business model, growth drivers, valuation, the competitive landscape, management team, balance sheet, and much more.

[00:00:46] Clay Finck: If you missed our previous two episodes on our best quality idea series, I’ve linked them in the show notes in case you’re interested in checking those out as well. Also at the end of this episode, Kyle and I are also going to talk about what we’ve been up to recently in our TIP mastermind community.

[00:01:01] Clay Finck: With that, let’s get right into today’s episode on Lululemon. 

[00:01:04] Intro: Celebrating 10 years and more than 150 million downloads. You are listening to The Investor’s Podcast Network. Since 2014, we studied the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Now for your host, Clay Finck.

[00:01:33] Clay Finck: Welcome to The Investor’s Podcast. I’m your host, Clay Finck. And today I welcome back my co host, Kyle Grieve for our Q2, 2024. Best quality idea series. So Kyle, as always, thanks so much for joining me on the show. Happy to be here. So this is our third episode we’ve recorded on the best quality idea series.

[00:01:53] Clay Finck: And for those not familiar, this is where Kyle and I take a look at our portfolios, take a look at our watch list and find a company that seems to potentially be a good Quality opportunity in the market at this time. So for today’s episode, we’re going to be covering Lululemon, and I’m going to kick off the episode with a brief overview on the company, go a bit on a tangent here, and then I’ll throw it over to Kyle and dive into some of the specifics.

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[00:02:17] Clay Finck: So Lululemon is quite an interesting company. I think it comes across many people’s screens when they’re looking at quality names and companies they are quite familiar with. I’m sure many in the audience are familiar with this brand. So for those who might not be as familiar with them, I’ll dive into their background and their founding story and what they do here.

[00:02:36] Clay Finck: They were founded in 1998 in Vancouver. And the company sells athletic apparel, and they really are targeting this yoga niche, but they’ve also expanded into some other areas. So running, weightlifting, and a lot of other types of workouts you can do. It’s really an athletic apparel company, and they’ve really benefited in my mind.

[00:02:55] Clay Finck: And from my perspective, from this trend to athleisure. So over the years, we’ve seen this trend towards people really valuing comfort and wearing something that’s a Comfortable yet stylish and less people are going to the office and wearing a suit or a dress and whatnot or You know out in public people wear this type of stuff all the time So a company like Lululemon has definitely benefited from this trend They went public in 2007 at the time of the ipo the stock was around 12 a share and at the time of recording It’s around 360.

[00:03:25] Clay Finck: It’s been quite volatile lately after the recent earnings release And that’s a compounded annual growth rate in the stock of 22%. And then you look at the top line revenue 2007, it was 148 million, and that’s grown to 9. 6 billion. And that’s a compounded annual growth rate of nearly 28%. What’s also great to see is that.

[00:03:45] Clay Finck: Essentially, all of this growth is entirely organic. So this means that they aren’t making a ton of acquisitions along the way to achieve this level of growth. So Lululemon is also a retailer. So they have 711 total stores globally. 367 of them are in the U S 127 in China, around 70 in Canada, 30 in Australia.

[00:04:05] Clay Finck: And then they’re in a number of other different countries, to a lesser extent, the UK, South Korea, and some other countries. And they also have a substantial presence online as well. They report their direct to consumer revenue, which I just view as the sales they’re doing in their e-commerce segment.

[00:04:22] Clay Finck: And one of the first things I like to do when looking at a big brand name company Like this is see if any well known investors own it. So Francois Rochon looks to be the only one that I could find. I was looking at data Rama for some of this data. He has nearly a 3 percent position in his fund, and he added 1 percent in Q3, 2022 during that pullback.

[00:04:45] Clay Finck: And that looks to be the most recent time he added a sizable stake according to data from Roma. And then according to nasdaq. com, it looks like he initially added the position in 2017 around 60 a share, but it looks like it was a very small initial position. So I actually had a call with Franchois Rashan the other day, and.

[00:05:06] Clay Finck: I had asked him about Lulu because I knew we were going to be recording this episode and I was happy to hear that he was disappointed a bit by the recent quarter they had, but he still believes in the long term growth trajectory of the business. And I’ll also mention that at the time of recording, Kyle and I do not own shares in Lulu lemon.

[00:05:23] Clay Finck: So zooming back a bit further, the company was initially started by Chip Wilson in 1998. And he really just wanted to create high quality clothing for women in the yoga niche. But now they’ve expanded into a number of different segments. And digging into Chip’s background a bit, It was in 1979 he founded an apparel company called West Beach Snowboard, which Kyle you’re familiar with.

[00:05:48] Clay Finck: And he ended up selling this company in 1997 before starting Lululemon in 1998. Chip was the CEO of Lululemon until 2005 and over the years he’s become less and less involved in the company. In 2012, he retired from his position as chief innovation and branding officer. And then in 2015, he stepped down from the board.

[00:06:08] Clay Finck: So Chip really just has developed this passion in apparel, and he actually claims to have invented the vertical retailing niche and selling clothing through retail stores is just incredibly difficult and Chip has proven the ability to build a strong and during business and Just did a really fantastic job and getting the company off the ground and getting them going.

[00:06:30] Clay Finck: I wish you were still involved with the company, but it is good to see that today he still owns 10. 7 million shares. That’s about 8. 5 percent of the company is worth over 4 billion. And turning back to the product a bit here, Lululemon is really well known for their yoga pants. I think you know, many women would say that.

[00:06:49] Clay Finck: Their pants are definitely comfortable, fashionable, and it’s exactly what a lot of women want. And whenever I go to the gym or grow out in public, women everywhere wear these. So it’s definitely not something people are just wearing to their yoga classes and calling it a day. Lululemon has certainly helped popularize this trend and other brands have come out with similar products.

[00:07:09] Clay Finck: You look at Athleta, Nike, other companies releasing very similar products. And I think one important distinction that we’re going to be getting into, Kyle, is that, companies like Nike focused on these big name athletes, especially Nike and Adidas, and athletes like you think of Michael Jordan, Tiger Woods, Lululemon, they started by partnering more so with everyday people within the yoga niche and had essentially partnered with these athletes in the niche to become brand ambassadors.

[00:07:39] Clay Finck: Lululemon is really differentiating themselves with a community feel as well as a higher quality product. And they needed these ambassadors to create that community feel and also communicate the benefits of why Lululemon is better or different than the other options on the market. And another interesting stat I found is that Lululemon still today caters very much to women.

[00:08:05] Clay Finck: So brands like Nike and Adidas, they get two thirds of their revenue from men, whereas Lululemon is the exact opposite. They get two thirds of their revenue from women. So they’re very much targeting a different customer than a lot of these other brands and positioning themselves a little bit differently.

[00:08:20] Clay Finck: A key theme I continually saw in researching Lululemon is that their products are definitely higher quality than many of the other brands out there. And Chip believes from the very beginning that if women were just to try on the pants, they would feel the difference. And a lot of people would just be customers for life from there.

[00:08:38] Clay Finck: Who knows necessarily how true that is. You certainly know better than me being from Vancouver. And Chip has said that he just wants to dominate the yoga niche and that sort of develops that customer loyalty and gives them the right to start to expand other markets and do some cross selling. I think over the years we’ve seen a lot of companies start to develop similar offerings.

[00:09:00] Clay Finck: And, Lulu has just shown that they can continue to charge higher prices than many of their competitors. Yeah, we can start diving into why that might be. 

[00:09:09] Kyle Grieve: Yeah, absolutely. Clay. So with Lululemon, its competitive advantage is quite simple. It’s the brand, right? Like you said, they have really high quality gear.

[00:09:17] Kyle Grieve: It’s easy to identify when someone’s wearing it. And the brand strength that they’ve built over time is showing how powerful it is now. So Hamilton Helmer points out in his book, seven powers that quote, branding is an asset that communicates information and evokes positive emotions in the customer, leading to an increased willingness to pay for that product.

[00:09:37] Kyle Grieve: Yeah. So he further breaks that down into two distinct sections, which are one effective valence and two uncertainty reduction. So just in case you get confused by those terms, effective valence is what you think about when looking at a popular brand like Coca Cola. So Coca Cola’s entire premise is based on the product evoking a positive emotion from their customers.

[00:09:59] Kyle Grieve: Which is why their advertising has always been geared towards, evoking that positive emotion. So because of the strength of the brand, people are willing to pay more for its products than a competitor because we know specifically what we’re going to get when we drink a Coca Cola. for instance, I can go into a Safeway and I can buy Coca Cola or I can buy a compliments branded Coca Cola.

[00:10:21] Kyle Grieve: And because Coca Cola has this brand that is built up now over a hundred years, It can charge a higher price than a competitor without losing any market share. So let’s loop this back into Lululemon. Lululemon has been around since 1998. obviously not quite the same tenure as Coca Cola, but it’s been around for a long time and the brand is very strong.

[00:10:40] Kyle Grieve: it now has about 25 years of existence where it has built its strengths inside the mind of its customers. So when we look at what is triggering the positive emotion in customers, I would attribute that to probably, about four different things. So one is product quality. Two is customer service.

[00:10:56] Kyle Grieve: Three is the first mover advantage and athleisure that you pointed out there. And then four is the community centered marketing. So I own quite a bit of Lululemon as do a lot of people that I know, because I do live in Vancouver where the company was created. So I had a pretty good view of the popularity of the brand quite early on, but unfortunately I didn’t take advantage of that by buying shares.

[00:11:17] Kyle Grieve: But one of the observations I had on Lululemon basically since day one was its quality. The fabric is super durable and it doesn’t break down. I have many shirts that I’ve owned for an embarrassing long period of time, simply because they just maintain themselves. other shirts like, I love Nike and stuff, buy Nike stuff for a long period of time, it just falls apart.

[00:11:37] Kyle Grieve: And, Lululemon just doesn’t do that. And the other thing I also like about it is that it doesn’t get super loose over time. So that’s one of the competitive advantages. I think the quality of the garments have. So another thing that’s cool about Lululemon is their return policy.

[00:11:51] Kyle Grieve: So just their customer service, they have this quality promise. Basically something happens to your gear that isn’t due to normal wear and tear, you can take it in and they’ll repair it for you. So I actually did this. I had a set of pants from them for about two years and eventually I just got a hole in one of my pockets.

[00:12:09] Kyle Grieve: And to be honest, it’s probably my fault. Like I think it’s just my keys in my pocket and just continuously digging into the hole and it made a hole in the pocket, but I took them back to Lululemon, zero questions asked. They gave me a little tag to come and told me they’d fix it. They’d give me a call after a few days and there you go, done.

[00:12:26] Kyle Grieve: Didn’t ask for money. They were really helpful and I really enjoyed that experience. It was zero, zero friction. And then moving on to the full being at the forefront of the athleisure movement, this is a movement towards wearing clothes that you can go to the gym or, even go out and, look reasonably nice.

[00:12:42] Kyle Grieve: And so it’s close up, both are comfortable and look good. And then another superpower of the brand is its ability to simply leverage the community aspect to help increase brand awareness. So clay touched on this already, how they don’t have to. Pay millions and millions of dollars. So all these athletes, they can just use their brand ambassadors to help spread the word.

[00:13:02] Kyle Grieve: So from 2020 to 2022, Lulu grew revenue by about 30%. And if you compare this to some of the other big names like Adidas, 6%, Nike, 5 percent and Under Armour, 2%. So the interesting part about this growth is that you’d probably assume that Lulu’s advertising budget as a percentage of their revenue was a lot higher than some of these other brands, but you should be wrong on that assumption.

[00:13:23] Kyle Grieve: So Lulu’s advertising expense as a percent of revenue was only 4%. 6%. And that’s first Nike, Under Armour and Adidas, which are all at least double Lululemon’s advertising expenses as a percent of revenue. Clearly their way of using their community, leveraging their community to sell their product was working really well and It’s resulting in all these cost savings that are dropping to the bottom line, which I think helps a lot with the profitability of the business.

[00:13:49] Kyle Grieve: So dumping into that and looking at some of the ways they keep their cost down is number one, that ambassador program. So I just talked about that, but they basically are partnering with regular people and then just, rewarding them not with money, but with product. And then these people obviously are well known in their communities or, they might be.

[00:14:08] Kyle Grieve: Yoga instructors or teachers of some sort of physical activity, their customers or clients see them wearing their gear and they like the way they look at it. They can tell their people about how much they like it and just spread the word and they get this organic growth from that.

[00:14:22] Kyle Grieve: And then second, they have these community events. So they have marathons and other events where they have product giveaways as part of their signup. So I had a good friend of mine. In the summertime, I did this outdoor jog. I think it was like Seymour Mountain where he signed up. It was with Lululemon.

[00:14:37] Kyle Grieve: You pay, a hundred bucks, you get to, they time you and everything. And then they also just would, they gave them a t- shirt. So that was pretty cool. And then obviously it gets you talking about that. He told me about it. Pretty cool little way they have to spread the word. So just another little point, I actually was an ambassador for Lululemon.

[00:14:55] Kyle Grieve: So I owned a personal training business and yeah, it was a really easy process. You just joined up at the time. This was probably like 15 years ago. I wasn’t at the level where they would just give me stuff. They would give me a nice, I think I got like 20 percent off of gear and basically all they did was they wanted me to tell them about what I thought about the gear.

[00:15:13] Kyle Grieve: what did I like about it or what did I not like about it? And it seemed like they were legitimately interested in trying to improve the quality of their gear and obviously make it really usable for the customers and improve it as well. So I thought that was really cool. And, obviously, I worked in a personal training setting, so people would see what I was wearing and that kind of leads off into their free advertising aspect.

[00:15:36] Clay Finck: And Chip really had this passion for innovation. I believe the term he used a lot in his book was technical apparel. So he is analyzing every single aspect of every single item of clothing and figuring out how he can make this as comfortable as possible, as fashionable as he can make it. And, there’s a couple of points related to what you’re saying there.

[00:15:58] Clay Finck: So at the top, you said that really what sets them apart is their brand. And when I think of Lululemon, I think of the status symbol aspect of it or what it signals when you’re wearing Lululemon. Chip was never big on like having a giant Lululemon logo, but when you see the clothing, you can tell what it is someone’s wearing.

[00:16:17] Clay Finck: So it reminds me of a Starbucks or an Apple. Here in the U. S. people don’t really care to pay more for these brand name products. They like what it signals. They like the quality and they know they could get maybe something a little bit similar for a bit cheaper, but they’re definitely willing to pay up for that brand of value and what it signals to others.

[00:16:36] Clay Finck: And that obviously gives companies like Lulu a pretty strong pricing power. And I also liked what you said about the return policy, just pointing to wanting to take good care of your customers. Many customers Are more than happy to spend thousands of dollars a year at Lululemon. And the lifetime value of a customer like that is just extraordinarily high.

[00:16:57] Clay Finck: And I just really like to see companies like Lulu that just, generally want to take really good care of their customers. give things like fix products for free, essentially, and I’m sure it’s going to last a long time and just deliver on their promise of quality. So what’s also interesting about Lulu Lemon’s business is they’re fully vertically integrated.

[00:17:16] Clay Finck: So the company is involved in every step of the production process, and they almost exclusively sell their own products. So if you want to buy their clothes, you pretty much have to go to their store or. Purchase from their store online. It looks like I was searching around online and it seems like you can buy some stuff on Amazon.

[00:17:34] Clay Finck: it seems like you can buy some things outside of their sort of ecosystem, but they seem to be very mindful of where you can purchase their products. And because of this control they have over how their products are purchased, it also gives them a lot of control on how their brand is perceived and experienced by their customers.

[00:17:54] Clay Finck: And in retail, it’s definitely a common practice to do a lot of discounting and because they don’t let other stores. Sell their clothing, then they have full control over how their product is sold. Of course, something like a discount can boost sales in the short term, but it can dilute the brand value over the long term.

[00:18:13] Clay Finck: So I think that’s part of the story of why they also have significant pricing power. And I also like to put a lot of emphasis on how much staying power. A company has, especially in retail, a product that can come out that’s super successful, is priced really high, creates a lot of profits, and that’s going to attract a lot of attention from competitors.

[00:18:34] Clay Finck: So when those competitors step in and try and, offer a similar product, maybe for a bit lower price, it really puts that company to the test of whether there’s a real enduring moat there. So since 2006, Lululemon has increased their revenues every single year, and they’ve had exceptionally high return on invested capital over that time period.

[00:18:55] Clay Finck: So 2006 to today, that’s 18 years where they’ve increased revenues and they’ve been able to overcome the competition that’s come in today. Their return on invested capital is 40 percent and return on capital employed is 46%. So yeah. Lululemon has definitely caught the attention of a lot of other retailers, and there’s been a lot of similar products that have been released, and I don’t think it’s really stopped them from, continuing their strategy of continuing to grow, really enter adjacent markets and continue to expand their store base, which we’ll be getting to as well.

[00:19:28] Clay Finck: And I almost think of their brands, like I mentioned along the lines of an Apple or a Starbucks, like it’s here to stay and it’s an enduring brand. And there’s more to the company than just selling a high quality product. It’s much, there’s much more to the story. 

[00:19:42] Kyle Grieve: Yeah, exactly. And, just want to rewind back to a point you brought up there about the vertical market.

[00:19:48] Kyle Grieve: So it’s funny because if you look at a company like Nike, they’ve actually stepped back, They’ve actually pulled their product off the shelves of some of the retailers. Like I know with a footlocker simply because the margins on selling online are higher and they feel like obviously they can control their product a little bit better that way.

[00:20:05] Kyle Grieve: So it just goes to show you that, It’s not to say that Lululemon’s business model is perfect or anything like that, but it’s just, it is a good business model when you can control more of your own product. And it’s interesting just to see some of these other big names like Nike moving in that exact same direction.

[00:20:22] Kyle Grieve: So I like the other thing you mentioned was that I liked how sales can go up and End up doing more harm than good to a company’s brand as excessive sales can signal that the brand isn’t as valuable compared to a business, which doesn’t require discounting its apparel to attract customers. So all these brands that discount all the time, obviously, that’s, that’s a signal to its customers that maybe it’s apparel just isn’t as valuable.

[00:20:44] Kyle Grieve: Whereas a business like Lululemon, they don’t have to do that. Yeah, they do have sales every now and then, but it’s like Apple, right? You go and buy an apple product. Yeah. It’s like never on sale. And if you find it on sale, it’s usually less than 10 percent and you feel like you’re really lucky.

[00:20:59] Kyle Grieve: So yeah, Lululemon is not a discounter. And I think that’s been a really big part of the reason that they’ve been able to keep their apparel at this high price for a long period of time. People know that the quality is good and they know what they’re going to get when they buy it. I just want to mention Hamilton Helmer one more time here.

[00:21:14] Kyle Grieve: So part of looking at the barrier to entry of a brand is that quote, a strong brand can only be created over a lengthy period of time of reinforcing actions, which he calls hysteresis, which itself serves as a key barrier unquote. So Lululemon has done an exceptional job. I think of developing its brand over multiple decades now.

[00:21:33] Kyle Grieve: And I think this further cements their barrier against incumbents. So athleisure, it’s a very competitive space. There’s tons and tons of brands that are trying to take market share and there aren’t that many barriers to entry. So if we look at the fact that I feel that Lululemon does have this somewhat barrier to entry, It shows that Lululemon is doing something right.

[00:21:53] Kyle Grieve: So one way that we can look to see if Lululemon is doing something right versus competitors is just to look at their margins. So if we look at their gross margins, Lululemon’s gross margins, 58%, whereas Nike Under Armour and Adidas all have gross margins below 50%. So this simply shows that they’re able to price their apparel a little bit higher than some of the other Titans of the industry.

[00:22:14] Kyle Grieve: And in Lulu’s case, that’s only strengthened. So if you look at, if we go back in time to 2016, gross margins back then were 48 percent versus the 58 percent today. So it’s just getting better and stronger. And that’s not all. So when we look at margins, we also want to know that money is dropping down to the bottom line and they’re getting more and more profits.

[00:22:31] Kyle Grieve: So if we could just use net margins for that case, that’s So once again, Lululemon shines very bright here. So net margins for Lululemon are 16 percent versus less than 10 percent for Nike, Under Armour and Adidas. So this means that when we run down an income statement, Lululemon is converting profits at just a much higher rate compared to some of these other super strong, well known athleisure brands.

[00:22:52] Kyle Grieve: So you can make the argument that it’s not the best comparison because these other brands aren’t exclusively in athleisure, they all sell shoes, for instance, and other types of sporting equipment where Lululemon doesn’t are, although Lululemon does sell shoes, but it’s a very small percent of its revenue right now, but I still think it shows the strength of Lululemon’s brand when you compare them to some of these other businesses.

[00:23:13] Kyle Grieve: So Like Clay has already alluded to, Lululemon has a vertically integrated business model and they don’t partner with other retailers to sell their products other than Amazon, which I actually didn’t even know that Amazon sold their products. So this means that they have full control over a few things.

[00:23:27] Kyle Grieve: One, pricing, two, the retail environment, three, brand power, and four, the customer experience. They don’t rely on letting others sell their gear, which, like I just talked about with that Nike and Foot Locker example, does compress your margins. So when you sell it all yourself, you’re able to really, protect your brand.

[00:23:45] Kyle Grieve: And like all good brands, you want to reduce uncertainty. As I previously mentioned, you don’t want people to go buying Lululemon pants and some people being really happy. And then other people having their stuff fall apart after a day, because then, you’re reducing that uncertainty. People want certainty and that’s why they’ll pay up for it.

[00:23:59] Kyle Grieve: That’s why. Clay said, with Apple and Starbucks, people are willing to pay. They know what they’re going to get. They know they’re going to get a really good product. And it’s very rare that they’re going to be disappointed. So one way that Lulu does this is by having uniform stores. So Lululemon stores are all laid out very similarly.

[00:24:16] Kyle Grieve: They have a distinct vibe to them and they express a higher end product. So if you step into a store, you’ll feel it yourself. it’s just, it’s a really high quality experience. It’s really clean. Everything is. Displayed in a really nice way. And you can tell that they put work into making it look the way that they make it look.

[00:24:32] Kyle Grieve: And then, yeah, when you shop at Lululemon, I’ve been to, of course, a whole bunch in Vancouver. I went to the one in New York. I know the experience was the same. It looks the same. The customer service is the same and only businesses that are selling their own product can really offer this advantage.

[00:24:46] Kyle Grieve: If you look at. Nike, for instance, if you were to go into a footlocker when they were holding their stuff versus, a champs or a Nike store, chances are that your customer experience is going to be different. And that kind of changes the way that your brand is seen in the customer’s eyes. So one comment I had on margin improvement is that part of the reason for the above average margins versus competitors is that Lulu has been growing its e-commerce business at high rates, which has offered a lot of economic benefits over selling in retail locations.

[00:25:14] Kyle Grieve: So we’ll be covering this in a little more detail later on. 

[00:25:17] Clay Finck: Yeah, and just to tap a little bit more into the innovation piece and the vertically integrated business model, having their own stores allowed them to easily test out new products and adjust to consumer tastes. So while, these bigger brands that don’t have as much control, they might be more hesitant or might even have more difficulty.

[00:25:39] Clay Finck: Testing out different products or testing out different variations, whereas that wasn’t an issue at all for Lululemon. And I listened to the audio book. Chip Wilson wrote this book called the story of Lululemon, and it started getting me up to speed on your level of how well you know, Lululemon. And it was a good read to get a sense of what the company is all about and what his vision was from the beginning.

[00:25:59] Clay Finck: And one thing that was interesting from the book was how Chip was really able to see these trends that were coming and capitalize them. So he could see, Hey, we’re in the early innings of this surfing trend or the skateboarding trend, like he did with West beach. And it was in 1998 when he started Lulu.

[00:26:15] Clay Finck: He’s Hey, I think yoga is still in its early innings. And he hit the ball out of the ballpark with that one, just like he did with his previous company. So these types of books that you’ve read of these stories, they’re great because you get to hear the story of How the business was born, the DNA, get a sense of, their culture and what was behind the thinking of the entrepreneur from the beginning and some of the growing pains they had to go through.

[00:26:38] Clay Finck: And you really gain an appreciation of what it takes to grow a multi billion dollar company. And just, it sounds easy when you just See these brands out in the streets, but there’s a lot of work and a lot of pain that goes into it from someone like Chip. One thing that I also found interesting from the book is that you talked a bit about the brand ambassadors and he really took to heart to get feedback from all these ambassadors and continually innovate the product.

[00:27:02] Clay Finck: So it’s this continuous iteration of, it’s not Chip saying, Hey, we got to do the product this way. It’s getting feedback primarily from a lot of women because they’re selling to women. So that’s who he’s getting feedback from. And that’s who a lot of these are. So we’ve really embraced innovation as a part of one of their core values.

[00:27:19] Clay Finck: And as you mentioned, they’ve really been a huge beneficiary to the trend towards e-commerce. So initially we may not have seen a huge growth in e-commerce when they started in 1998, but. Today, it’s a core part of their business. So if you look back five years ago, and you look at the revenues for their store sales, and then you look at their e-commerce in 2019, they did 2.

[00:27:41] Clay Finck: 1 billion in sales in their stores. And then they did 850 million, in their e-commerce segment. And you fast forward to today, the stores did 4. 4 billion in revenue. And then the e-commerce segment did 4. 3 billion. So the e-commerce segment has nearly surpassed the e-commerce Their store sales, despite the in store sales continuing to grow at a fast clip, they’re continuing to open new stores.

[00:28:04] Clay Finck: So it’s, there’s just so many tailwinds right now behind the business. And 15 years ago, the e-commerce segment barely existed. And then, right after they went public, they actually released their e-commerce. And I think that’s another example of Chip seeing where things were heading. He definitely wanted to control.

[00:28:21] Clay Finck: How the brand was viewed in the eyes of consumers. And he had to be really thoughtful, releasing that e-commerce segment because it’s a much different ballgame than having your own stores. And they just, again, knocked the ball out of the ballpark on that one. And then I also wanted to touch on revenue by geography.

[00:28:37] Clay Finck: So Lulu initially started in Vancouver, started to expand in the U. S. and did so very successfully. when you look at over the past year, over 65 percent of revenue came from the US and then ever increasing part is coming from China. So China is definitely a key part of their growth strategy. they didn’t receive any revenue from China three years ago and since then they’ve just seen substantial growth.

[00:29:01] Clay Finck: So today nearly 12 percent of revenue comes from China and again, that segment’s just growing very rapidly. It grew by over 60 percent over the past year. Revenue in the U. S. grew by around 12%. So really a lot of that growth is coming from China, but it’s a smaller segment. You’re still seeing pretty good growth from the U.

[00:29:19] Clay Finck: S. and then e-commerce is also providing them a lot of growth as well. 

[00:29:24] Kyle Grieve: Yeah. So the growth along geographies has been great, as Clay pointed out, especially when you look at China and outside of North America. But they have a lot of growth drivers going ahead. So they currently have a growth initiative that they call the power of three.

[00:29:39] Kyle Grieve: So this was initiated in 2022. The main goal is to double the business’s net revenue from 6. 5 billion in 2021 to about 12. 5 billion by 2026. So the three growth initiatives are one product innovation to guest experience and three market expansion. So they’re trailing 12 months and net revenues today are about 9.

[00:30:01] Kyle Grieve: 6 billion. So they look pretty much right on schedule compounding revenues around that kind of 15 percent per annum number. But let’s dig into some of these growth levers in a little more detail. So product innovation is the DNA of Lululemon. As Clay was just talking about with Chip Wilson, like that was a really big part of the company and they’ve continued to do that.

[00:30:19] Kyle Grieve: it’s not really surprising that they’re planning to keep their gear fresh and continue expanding to adjacent markets. So They started in yoga, but obviously, clay listed off a bunch, but I’m just going to relist a couple here. Other verticals are in, which is running, CrossFit, hiking, swimwear, golf, tennis, gym gear.

[00:30:36] Kyle Grieve: They’re also dipping their toes into footwear now as they offer men’s and women’s shoes as well. that’s in its very infancy. So it’s worth noting that like Clay said, their sales are two thirds to females and one third to male, but this has grown from 0 percent male share to, to where it is today, which is very impressive because it’s been growing at a very fast pace.

[00:30:58] Kyle Grieve: So when it comes to the guest experience, they’re at the forefront of omnichannel sales. Which is simply that they have different sales channels that customers can buy their products from. So while the retail segment has been growing revenues at about 15 percent per annum for the last five years, Clay just mentioned it was 12 percent in the last year.

[00:31:17] Kyle Grieve: It’s decent growth, nothing, super spectacular. But when you look at their direct to consumer growth, which is like Clay also pointed out, which is essentially just their e-commerce. This has grown at 40%, so it’s growing like an absolute weed. And part of the strength of the direct to consumer portion of the business is the community angle that I already outlined.

[00:31:36] Kyle Grieve: So this serves as an excellent augment to their retail sales channel and allows for the growth of their brand, utilizing e-commerce. So I just wanted to share a really interesting bit of info. I listened to a really good interview with Chip Wilson that he had with Tim Ferriss.

[00:31:51] Kyle Grieve: And this is when he was talking about how he crafted his stores to best serve customers. So quote, basically, I was setting it up because I understood clearly from listening to women that they were time constrained. And if they could get in and out of a store in under 10 minutes with exactly what they wanted, Then I was actually saving them a hundred or 200 because I always came from that.

[00:32:09] Kyle Grieve: Our customers were making a hundred dollars an hour coming into the store. So then we set up the right amounts of change rooms so they never had to wait for a change room. We hung tags all on the same side. We had the price that was big, the size that was so big. So that it was easy to read.

[00:32:24] Kyle Grieve: You didn’t have to search for anything. The store was set up functionally, so you’d get what you want in the change room. There were three way mirrors, so a girl didn’t have to come out, have someone to ask how they looked in something. They could actually check their own sides out if they wanted to inside of the change room.

[00:32:38] Kyle Grieve: Our cash registers had the fastest checkout. By the time you scanned it and got the price out, you’re out the door. So I think women really appreciated that. So these are just a good example of some of the very small details that Lululemon tried to pay attention to that really stood out to me. And I think this has helped really keep their brand strong because their customer service obviously is very customer centered and they want to just serve them at a very high level.

[00:33:01] Kyle Grieve: So when we look at market expansion, they’re obviously targeting China and the rest of the world to generate a lot of the future growth. As Clay pointed out, North America is slowing down. It’s also worth noting that on menswear. They’ve done a very good job of growing this segment. So if we look back at their initiatives, they had another initiative, I believe it was in 2020 or 2021, where they were going to double men’s revenue by 2023.

[00:33:25] Kyle Grieve: And they did that very easily. So another part of the expansion plan was to quadruple revenue outside of North America. So in 2021, this figure was 624 million as of today is 1. 9 million. So they’ve nearly achieved that goal. They’ve tripled and they still have two years remaining on their initiative.

[00:33:41] Kyle Grieve: So I think that they’ve executed at a very high level. 

[00:33:46] Clay Finck: So next I wanted to talk a little bit about what I found on the competitive landscape for Lululemon. There’s a host of competitors to mention here. So the global activewear market is massive. It’s north of 350 billion and Lululemon only captures 2 percent of this market, despite them being a very big company today.

[00:34:09] Clay Finck: Lululemon focuses much more on the yoga niche. So the yoga niche is a much smaller market. It’s estimated to be 25 to 30 billion, and they capture around 25 to 30 percent based on the data I was seeing on this. The activewear market is very stable, very mature. It’s growing at around three to 4 percent per year.

[00:34:29] Clay Finck: So around the inflation rate and the yoga market’s growing a bit faster, it’s growing at over 8 percent a year. So that’s a nice little tailwind for Lululemon being focused on that niche. And then when you look at the major competitors, we’ve talked about the legacy players, Nike, Adidas, Under Armour, and then you have these premium brands popping up that I feel like I see a new one every year that I’ve never seen before that are, somewhat similar to Lulu, but maybe they’re targeting a different type of customer, different type of products.

[00:34:58] Clay Finck: So some of the players that I found were sweaty, Alloyoga, Fabletics, Beyond Yoga, Public Rec, and then a member of our mastermind community also mentioned Viore, which he said his family swears by. It’s tough to say what some of these brands are really targeting, but many people I’ve talked to that are familiar with the industry have stated that this industry is very competitive and everyone knows that retail is not an easy game to play.

[00:35:26] Clay Finck: And I just think a lot of these businesses have different strategies though. So some might sell yoga pants like Lulu does, but they might be targeting a different type of consumer. Maybe it’s more casual. Maybe it’s a different segment within the women’s market or whatnot. A lot of companies are really just trying to capitalize on this trend of athleisure.

[00:35:45] Clay Finck: And as I’ve hosted the show for some time now, I’ve realized that People like to oversimplify some of these things when it comes to particular markets. I think in the case of Lulu, they might say that this space is just way too competitive. And, it is true. It is really competitive and there’s a lot of players, but you can’t overlook just how big this market is.

[00:36:06] Clay Finck: And there’s plenty of different segments within the market and plenty of different types of customers. So Lulu doesn’t have to Take 90 percent of the yoga market to be successful. And, after doing some research, it seems that Lulu definitely is still a very high quality product relative to many of these other brands.

[00:36:24] Clay Finck: And they still have strong brand recognition. And I think that’s one of the bigger risks we should maybe touch on just, They need to keep that brand strength intact and that can’t be jeopardized, going forward. And it’s a really key part of their continued strategy of growth in China and growth of their e-commerce segment.

[00:36:43] Clay Finck: And there’s just so many companies out there selling apparel and they’re going to need that type of recognition, especially to earn the returns on capital that they have. And really at the end of the day, any company can make a high quality legging or a high quality shoe or whatnot. It’s really going the extra mile.

[00:37:00] Clay Finck: And, creating that positive emotional response that you highlighted towards the beginning. And clothes to a certain extent are a commodity. And Chip realized this. He saw the skateboard and the surf brand, it was just, he just saw how difficult it was to have a sustained high quality brand.

[00:37:16] Clay Finck: And, So many of these types of segments just become commoditized. And that, I think, served as a strong lesson for him in building Lulu. And, he knows that he needs to figure out a way to, I guess it’s not him. They have a new CEO today, but they know they need to have reasons to justify the higher prices of charge.

[00:37:33] Clay Finck: And then, definitely offer a good value proposition, a differentiated product, the community aspect. Yeah. So maybe you can mention a couple of the risks with Lululemon and, some of the things, investors should watch out for with them. 

[00:37:49] Kyle Grieve: a lot of these retail businesses have similar risks and, Clay pointed out a lot of them, but I’ll just add a couple of my own.

[00:37:56] Kyle Grieve: So one of the risks is like product assortment. So obviously, with a lot of these. Retailers that are, creating products for specific seasons. You have to make sure that you have the right gear for the right season. And then the other thing that I find really interesting, especially a company like Lululemon is, they’re really well known for their leggings, right?

[00:38:14] Kyle Grieve: And, but they’ve diversified away from it. But at the same time, they’ve still stuck with their core products. They know their leggings do really well. So they’ve done a good job of innovating and creating adjacent products around the leggings, but they’ve also been well diversified, Making jackets and backpacks and other, socks, boxer briefs, things like that.

[00:38:37] Kyle Grieve: I think they’ve done a really good job on that, but obviously product assortment, it matters a lot. So you can look at inventory and I’ll be talking about that a little bit shortly. So I won’t get too much into that. You have to maintain a level of excitement for your products. That just comes down to making sure that your product is functional.

[00:38:52] Kyle Grieve: And obviously, Clay’s pointed out multiple times that Chip Wilson was really into emphasizing that their gear was functional and worked really well. And another thing that’s really important for brands is obviously staying on top of your customers’ minds. If your customers’ minds are transferring over to another product, chances are that it’s going to be hard to get them back to focusing on yours.

[00:39:11] Kyle Grieve: So that just comes through. Advertising and they don’t have to advertise that much, but you just see so many people wearing it and it’s pretty easy to identify that, that people are wearing it. So it’s the self reinforcing thing, but obviously it is important to keep it top of customers minds.

[00:39:27] Kyle Grieve: I know one of their biggest suppliers, I believe their, one garment uses this, they call it Luon, I believe L U O N. And, I think almost all of that comes from Taiwan. if you’re looking at specific risks, obviously there’s always geopolitical tensions going on between China and Taiwan.

[00:39:44] Kyle Grieve: if something were to happen, that could be a pretty big negative for their supply chain. And then just obviously be back on that is just the China risk. obviously China has been a huge growth lever for them. So if something were to happen with China and our relations with them went south, there’s a chance that, Everything in China could go to zero.

[00:40:04] Kyle Grieve: I think those are the biggest risks to pay attention to. Are there any others that you can think of clay? 

[00:40:09] Clay Finck: No, I think that it hits it. How about we turn to management? 

[00:40:13] Kyle Grieve: Absolutely. So when we look at management, one thing that I like to look at, this is just zooming out just in general is I like to look at management that is forward thinking and isn’t just trying to look to wall street and tell them that next quarter is going to be good.

[00:40:25] Kyle Grieve: I actually prefer someone who just is looking, five years into the future. So I really like it. The fact that Lululemon has this power of three where they are looking five years into the future. So we already covered the growth initiative, the power of three, but I really like the fact that they have these kind of long term views, which allows them to accept the fact that, yeah, okay, there might be quarters, like the last one that aren’t so good, but we’re focusing on where we’re going to be in five years.

[00:40:51] Kyle Grieve: And I really like that. So I think that really shows you just that management is focused on looking out. And, then the thing that’s cool is that, some of these management teams or businesses that just aren’t as good, they’ll get these initiatives and then they’ll fail at it. And then you look, so if you look back in time, they have these initiatives.

[00:41:09] Kyle Grieve: You look now, they don’t talk about it at all. And that’s a really good signal. That’s probably a business you don’t want to be in. And I was just really impressed because I actually think that Lululemon had a five year program and I can’t remember the exact date, but they smashed it. And basically they had to come up with this new five year program.

[00:41:26] Kyle Grieve: I don’t know how many years in advance, but. Basically, like the five year program, they smash it and they just did another one and that’s where they are now. So that’s execution, I think, at a really high level. So Lululemon is laser focused on growth right now. New store openings are growing at a five year compound annual growth rate of about 8.

[00:41:43] Kyle Grieve: 7%. They’ve gone from 491 to 711 stores, and these stores obviously cost money to open. So trailing 12 months capital expenditure is 6. 8%. And if you contrast that with five years ago, still 6. 8%. So we could probably continue to expect them to deploy capital into growth and maintenance at probably that’s the 0.

[00:42:04] Kyle Grieve: 8 percent range. So if we look at fiscal 2023, depreciation and amortization was about 291 million. And they spent about 638 million on CapEx. 45 percent of CapEx is spent on growth and the rest on maintenance CapEx. One thing that’s cool about Lululemon, they have zero debt. They have a 400 million credit facility from 2021 that hasn’t been drawn on yet.

[00:42:28] Kyle Grieve: They really don’t need too much debt. Just looking at their balance sheet, they have a very strong balance sheet. So they have a billion dollars in cash, which isn’t that much. But like I said, they don’t have any current or non current debt liabilities. So they’re in a very strong position to continue growing without the need for debt or to issue equity and obviously dilute shareholders.

[00:42:48] Kyle Grieve: So super big strength of the business. I also like how they’re keeping their, it’s been growing a little bit, they’re not like Berkshire that has whatever. I don’t know. How much is that now? 158 billion that they can’t put to work. Obviously, Lululemon is a way smaller company, it’s nice to see that they can put their money to work and they’re doing a really good job of that.

[00:43:09] Kyle Grieve: I want to just touch on inventory levels as well before we get back into management, but Yeah. I think they’re doing a really good job of managing their inventory. Inventory has grown at about 23 percent over the last decade versus about 21 percent in revenue. So I think they’re doing a really good job of making sure that they’re turning over their inventory and not being stuck with inventory that they can’t sell, which is a problem for many retailers that, aren’t doing quite so good of a job.

[00:43:32] Kyle Grieve: So yeah, and then just touching on dilution. Obviously I mentioned that due to the fact that they probably don’t need to issue equity, they’re probably not going to dilute shareholders. So the only other way, obviously they can dilute shareholders with share based compensation. And it’s pretty nice to see that their share based compensation this year was 0.

[00:43:49] Kyle Grieve: 1 percent of revenue. So super low and management is also on top of that. They produced a share count from about 142 million in 2016 to about 126 million today. So it’s nice to see that. But obviously, while it’s nice to see the share count going down, the buybacks were made when Lululemon’s price earnings were about 30 times or higher.

[00:44:08] Kyle Grieve: if we look at the yield on that, we’re getting a, at most about 3. 3 percent earnings yield. And obviously we’ve been in this ridiculously low interest world. So if you’re comparing it to interest rates, then yes, buying back your shares, I guess makes a little bit of sense. But when you add in the facts, like Clay said, with this astronomically high ROIC, And just going back in time, the lowest ROIC has been in the last decade was 27%.

[00:44:36] Kyle Grieve: I don’t know, you can make your own judgment call and whether you’d get the 3. 3 percent from buybacks or just reinvesting in the company. So I want to move on now to manager compensation. So they have an interesting plan where executives must retain a percent of their annual salary as shares in a little lemon, which I like, the CEO must have five times their salary and shares and other executives must have three times.

[00:44:59] Kyle Grieve: So they are allowed to include options, performance stock units and reserve stock units in this number. But, I like that at least it keeps the management somewhat aligned with shareholders. Base salary for executives is reasonable. So the CEO, Calvin McDonald had a base salary of 1.

[00:45:18] Kyle Grieve: 3 million. Other named executives are between 700 and 900 K. This seemed to be somewhat aligned with competitors like Nike. So the options plan is very lucrative though, for execs and little lemon. So Calvin McDonald has received a total compensation of 10. 6 million in 2020. 11. 3 million in 2021 and 15. 6 million in 2022.

[00:45:39] Kyle Grieve: Just to compare Nike CEO received 10. 2 million in total compensation in 2023, according to salary. com. So as for the incentive program, the CEO is paid on total shareholder returns, net income and operating income growth. I’m not crazy about total shareholder return incentives simply because it can make it so that a CEO will take short term risks in order to increase their share price at a fast rate in the short term, but unfortunately for the long term, that usually just ends up not working out very well.

[00:46:13] Kyle Grieve: So the profit incentives also can be bad for certain businesses, but in my opinion, it actually does make really good sense for Lululemon. So the reason that earnings incentives can be bad is similar to shareholder return. You can basically just spend a bunch of money, buy a company that has a bunch of earnings, and then just bolt that onto your business.

[00:46:33] Kyle Grieve: And bam, there you go. You just increased earnings without really doing much. And you can actually do that without creating any value and actually destroying value. But the thing that I think that makes sense for Lululemon is that they’re not an acquisitive company. As Clay pointed out earlier, all their growth is organic growth.

[00:46:48] Kyle Grieve: They’re not having to buy other things. They have gone in and bought a few things that I will mention, but they’ve been very small. overall the incentive program is, I think it works well for the company. And then also the, if you look at Lululemon’s operating margins over time, they’ve done really well.

[00:47:06] Kyle Grieve: And I think that’s probably part of the reason that the CEO is incentivized for that. So if you look at operating margins from 2015, they were about 21 percent trailing 12 months, 23 percent and the net margins in 2015 were 13 percent and today they’re 16%. So you’re seeing a really nice gain in there.

[00:47:22] Kyle Grieve: And that’s probably partly driven by the incentive program of management. As of their last proxy statement of April 2023, insider ownership isn’t great, so this is one of the bigger, I guess you can call it a yellow flag, but there’s about 693, 000 shares that are owned by executives and directors as a group, and that includes options.

[00:47:42] Kyle Grieve: So this only represents about 0. 5 percent of diluted shares outstanding. As Clay pointed out, the founder, Chip Wilson, still owns about 8. 5 percent of the shares outstanding. But it is worth noting, he’s not part of the business anymore. He’s, he’s not on the board or anything like that, or making decisions.

[00:47:57] Kyle Grieve: So I think it is worth it, though, to look at how much as a percent of shares that the CEO has as a percentage of his net worth. So I use something called wall mine, which is the site. And, It said that the CEO, Calvin McDonald’s net worth was around 50 million. This was at the end of 2023.

[00:48:14] Kyle Grieve: And they said that he also owned about 38 million of Lulu stock at that time. So that means about 76 percent of his net worth is in Lululemon stock, which I think is a pretty good alignment. And now, if we look back at Calvin McDonald’s track record as the CEO of Lululemon, it’s been really good. He took over in August of 2018, and from then until today, he’s compounded Lululemon’s share price at 18.

[00:48:36] Kyle Grieve: 3%. If we look at just how much he’s grown earnings per share, he’s achieved a 36. 3 percent kegger. So I think he’s doing a very good job on that front. And then another metric that I like to use that I stole from the buffet here is the rule of one, which is basically each dollar retained by the company should produce at least a dollar of value for shareholders.

[00:48:58] Kyle Grieve: So if we just look at the time that Calvin’s been in charge, we can see that he’s retained about two and a half billion dollars and put that back into the business to work. So for each dollar that had been retained by Lululemon, they’ve created 12 and 13 cents of value for shareholders. So that’s very good.

[00:49:14] Kyle Grieve: Just a little bit of background on Calvin. He was the president of Sephora Americas between 2013 and 2018. Sephora is owned by LVMH, which is good, but it also means that it’s a little bit harder to get an accurate picture of his performance at Sephora because they’re just folded in as a consolidated number.

[00:49:34] Kyle Grieve: he was there for five years. I assume he did a pretty good job because he didn’t get fired or anything. He actually left the business to take the shot with a little lemon. Then another thing, obviously with CEOs, I just like to make sure I delineate between if there are types of CEOs that really love attention or if they just avoid attention.

[00:49:51] Kyle Grieve: So Calvin’s appeared on CNBC and a few podcast episodes. It’s not a lot, but it’s just something to observe. So yeah. He’s not a recluse by any means, I don’t think he’s wasting too much time on doing public relations. And just the final thing I want to mention, I did mention about mergers and acquisitions is they actually have had one acquisition.

[00:50:11] Kyle Grieve: So this was the mirror. So you might’ve seen ads or seen this talked about closer and more in the COVID times when everyone was staying home, but it was basically just a mirror that you hung up on your wall and you could obviously look in yourself, but it also acted as like a giant iPad where you could just do exercise in front of it.

[00:50:29] Kyle Grieve: And it would tell you what to do. So at the time, Peloton obviously was doing really well because of this huge movement towards home fitness. And so Lululemon wanted to get a piece of that. So that’s why they bought Mirror for 500 million. As of October 2023, they just wrote that investment down at a value of only 72.

[00:50:48] Kyle Grieve: 1 million. it’s basically shut down and it didn’t work out very well. They’re not selling the hardware anymore. In its place, they made a five year deal with Peloton. It’s pretty tough to evaluate this just because I think it’s new. And as far as I could see, they weren’t really talking too much about how much money that was giving off.

[00:51:06] Kyle Grieve: But the point being that mirror was not a very good investment for them, but luckily it was a little bit smaller and it didn’t move the needle much for them. 

[00:51:16] Clay Finck: Thank you for that wonderful breakdown on the risks and the management. One of the reasons that we started this series, Kyle, is that we very much align on how we want to invest in stocks.

[00:51:26] Clay Finck: We believe that winners tend to keep on winning. And I just had an episode come out. it’s going to be after this is recorded. Joseph Shaposhnik, and he shared some wonderful reasons why we should focus on business quality. And if you enjoy this episode and haven’t tuned into that one, I’d highly recommend it.

[00:51:43] Clay Finck: He pointed to a statistic on, these quality businesses tend to remain high quality and low quality tends to remain low quality. I’m also reminded when you mentioned the mirror acquisition, it’s very unfortunate to see, but it reminds me of Pulak Prasad’s point that these quality businesses, they’re able to take some of these risks and take, maybe go out and make an acquisition.

[00:52:06] Clay Finck: And it’s just the core business. It doesn’t affect it at all. The business is turning along just as it always has. And if you would have bought the stock, when they made that mirror acquisition, you would have turned out just fine as an investor. So yeah, it is unfortunate that they made that mistake, but hopefully they learned from it.

[00:52:24] Clay Finck: So I wanted to turn here to valuation and capital allocation. I’ll try and keep it as simple as possible. It’s hard not to mention too many numbers when talking about valuation, but given my love for numbers, sometimes I just can’t help myself. So at the time of recording, The stocks actually traded down from their recent quarterly results.

[00:52:44] Clay Finck: And that’s how I got brought up on my radar. And some of the people I follow, I’ve shared write ups on Lulu. So it’s pretty funny how a lot of people in our circles have been attracted to this quality name. And yeah, sometimes, if a company has returned on invested capital, 40 percent is down from 360, that catches a lot of people’s attention.

[00:53:04] Clay Finck: At the end of 2023. Yeah. Like I mentioned, the stock was over 500. it’s down 30 percent from a tie and in the recent quarter revenue increased by 16%. The bottom line net income also increased by 16%. And their store count today sits at 711 recent quarters. They opened 25 new stores. So they’re continuing to expand their footprint there.

[00:53:27] Clay Finck: And when we look at the multiples for Lulu it seems to be attractive relative to where it’s been historically. The EV to ebit, for example, now sits around 20. So you can, you’re looking at around a 5% earnings yield, with a company that’s growing at a pretty good pace. Looking historically at this multiple, this figure is pretty distorted in 2020 due to the shutdowns and a lot of their stores being closed for a period.

[00:53:54] Clay Finck: Just prior to COVID, this multiple, just for reference, was 38. And ever since 2022, we’ve really seen it normalized and now it’s hitting new lows. When we look at Nike’s EV to EBIT, it’s 23 and their return on invested capital isn’t near as high as Lululemon’s. And I think we could also argue that Lululemon is a higher quality business, but that’s discussion for another day.

[00:54:17] Clay Finck: And I don’t think the stock is drastically overvalued, looking at the company’s return prospects, their growth prospects, And, how they’re reinvesting. So I like to look at them. What is the company doing with their current earnings? And then how is that going to affect their future growth and revenue and earnings?

[00:54:37] Clay Finck: And to start with that, I like to look at a Buffett’s owner’s earnings figure. So this is calculated as net income plus depreciation and amortization, other non cash charges. Minus maintenance capex and the maintenance capex is something we have to estimate ourselves as investors. So the company has their capital expenditures and we have to estimate some portion of that’s for growth.

[00:54:58] Clay Finck: Some portion of that is just to maintain their existing business. So I estimated the owner’s earnings to be around 1. 5 billion and then their market cap today is around 45 billion. So that gives us a nice round multiple of 30 to put things in perspective. And then with that cash flow, close to half of it is being allocated towards capital expenditures, maintenance and growth.

[00:55:20] Clay Finck: And a lot of the cash flow is also going towards sherry purchases. I think some more conservative investors might like that capital being returned to them, but some could also argue that it’s when the stock starts trading up, it’s probably not great for them to be doing repurchases because, maybe they could distribute the dividend.

[00:55:42] Clay Finck: it’s hard to expect a company like this to reinvest 100 percent of their cash flows. It’s just really difficult to do. And I also like to see stable conservative growth over time too. So yeah, some investors probably like the buyback. Others might not like it as much. And then the remainder, there’s a little bit of cash that likely just sticks on the balance sheet and it gives them some optionality, gives them the ability to potentially invest in new product lines and continue innovating.

[00:56:08] Clay Finck: So I like that they’re fairly balanced in terms of their capital allocation. And I like that they, like you mentioned, have a really strong balance sheet. They currently don’t pay a dividend. Maybe we’ll see a dividend at some point in the future. This talk runs back up and gets to elevated levels. So assuming that they’re able to keep the U S segment growing at double digit rates, say 12 to 15%, their expansion into China continues to go as planned.

[00:56:32] Clay Finck: And then the e-commerce segment continues to grow at a healthy clip. I’d personally expect to return something like 12 to 15%. Generally this company is under promised and over delivered. So we could see rates higher than that. In the past couple of years, their revenue growth rates have come down a bit.

[00:56:47] Clay Finck: They got a huge boost post COVID. And now you’re seeing things start to normalize. And, this is a stock, like I said, a winner that tends to keep on winning. year after year, it’s just been a strong outperformer and, it’s sad, but I would argue a reasonable valuation today. I have no reason to believe that strong outperformance won’t continue.

[00:57:05] Clay Finck: And. This is a stock that’s had its fair share of moderate pullback since 2006. And as with most stocks in the market, it’s one of these, I think you could have taken advantage of the mood swings in the market and have pretty good returns if you’re a more opportunistic investor. And, on the flip side, if we look at the potential downside, we see the slowing revenue growth 15 or 16 percent in the recent quarter. A year ago, the revenue growth rate was 30%.

[00:57:31] Clay Finck: So they, again, they got a big boost from COVID and, They’re seeing slowing growth in the U. S. and management guides for revenue growth of around 11 to 12 percent in fiscal year 2024, but they still expect revenue to grow at 15 percent over the longer terms. retail is a bit cyclical and they expect 15 percent growth over the next five plus years.

[00:57:53] Clay Finck: Again, they tend to over deliver and the share price drop might be a good opportunity for investors. I want to get into more of a blue Chip, a well known name that a lot of investors already know about. Looking back historically, the growth rates have been quite attractive. So for example, we’ve mentioned a lot of numbers on this show, but over the past five years, free cash flows have compounded at 22 percent per year.

[00:58:15] Clay Finck: And that’s while they’re doing a lot of buybacks, they’re not having to reinvest a hundred percent of their capital to achieve that exceptional growth. And yeah, that growth in free cash flow has led to the stock being a strong compounder. 

[00:58:28] Kyle Grieve: Yeah, Clay, I agree. I think your valuation assumption, sorry, all sound very reasonable and conservative with kind of an embedded margin of safety into those numbers.

[00:58:36] Kyle Grieve: With that assumption that you are making a 12 to 15 percent range with some upside optionality, just as you said, they do keep out delivering. So I feel that’s a good kind of base to build off of. If we look at part of the life cycle that Lululemon is in, they’re still in the growth stage, but they also have embedded competitive advantages.

[00:58:56] Kyle Grieve: they’re still reinvesting capital back into the business at high returns on invested capital, which is great. They still have a lot of reinvestments to go before they become a mature business. And start to be forced to just redistribute earnings back to shareholders. I think if we look at the business over the next few years or decades, if they are redistributing back shareholders, that probably means that, returns are probably just going to go down a little bit because it just means that they’re not able to sustain their high returns on invested capital if they’re going to pump more and more money into the business.

[00:59:29] Kyle Grieve: And that’s why they’re redistributing it. So right now I really like the balance of the business being mature, but still growing and reinvesting and not having to redistribute everything to their shareholders. So once I own a business, let’s say I own Lululemon, I don’t. I like to keep track of key performance indicators.

[00:59:47] Kyle Grieve: KPIs. So for Lululemon, if it was, if I was to own it, it would come down to me tracking the following. So number one would be returns on invested capital. We’ve obviously talked a lot about that and thrown out a lot of numbers, but essentially I would just obviously if it could keep growing, that would be great.

[01:00:01] Kyle Grieve: But given how high it is, if they can just maintain it, or even if it dropped a little bit and they just maintain that number, I’ll be very happy. But I think it’s very important that if you are seeing a steady downtrend and the returns on invested capital. That could be a very good signal that their moat, which is their brand strength, is starting to erode.

[01:00:18] Kyle Grieve: And that would be something that you need to pay very close attention to on the same front looking quantitatively. If we look at things like net margins and free cash flow margins, we obviously want to see a perfect world. It would be awesome if they could continue increasing those.

[01:00:31] Kyle Grieve: They can’t keep increasing it. Into infinity, otherwise become a hundred percent and that’s not going to happen. Just going from, I think, I mentioned earlier that net margin has gone from 13 percent to well, 16 percent from 2015 to today. That’s only a 3 percent difference, but that adds a lot of value to the business.

[01:00:48] Kyle Grieve: I’m not sure what they can take those margins to, but I would definitely pay attention for the same reason. If you’re seeing margins come down, that means that they’re probably having to spend more money in other areas of the business. And that also is pretty good. KPI to watch to make sure that their competitive advantages are being maintained.

[01:01:04] Kyle Grieve: I would definitely pay a lot of attention to their growth, especially outside of North America. We know North America is, now it’s getting into that more mature. Base, it’s still growing at a really nice rate, you’re not going to see it growing at the same rates that it has in history.

[01:01:19] Kyle Grieve: And you’re not going to see it grow at the same rates that China and the rest of the world is going to be growing at. So I would definitely be paying attention to how those things are growing specifically, because if you are buying this too. Get growth, then, that’s going to be one of the bigger growth drivers.

[01:01:34] Kyle Grieve: I would also be paying attention to men’s product revenue. We know that they’ve grown that from zero to a third of their revenue today. Will it ever be 50%? I don’t know. Probably not. I just think that with the DNA of the company embedded in women’s wear, it’s probably always skewed to that.

[01:01:49] Kyle Grieve: But, could it go to 40 percent or 45%? I don’t know. Maybe. And obviously that would provide a lot of value for shareholders. Store count. So this is just a general number for a retail company. Obviously more stores you have, if they’re all selling stuff, selling a similar amount of stuff, you want more stores cause you’re going to be making more money.

[01:02:08] Kyle Grieve: Another thing also, that’s really interesting just for these kinds of omni channel businesses is that sometimes, someone might go into a little lemon. Not feel like buying anything, but just go there to try stuff that gets the brand name into the top of their mind. Maybe a little, a couple of days later, they think about it.

[01:02:23] Kyle Grieve: They like, they say, Oh, I like that, that, and that go online, buy it online. There you go. You got your direct to consumer e-commerce up, which obviously matters because the more stores you have, it just means that you got more foot traffic and more people talking about your product. And then lastly, I just talked about the DTC or the e-commerce segment.

[01:02:40] Kyle Grieve: It’s growing insanely fast and that’s going to be a huge growth driver. So we definitely would want to see that business continues to grow at high rates. 

[01:02:49] Clay Finck: Thank you for mentioning the KPIs there, Kyle. I can’t remember where I’ve read it, but I believe I read that Nike’s business in China is 10 exercises of Lululemon.

[01:03:00] Clay Finck: So presumably There’s a long runway in China, especially. So that wraps up our discussion on Lululemon. Before we close out the episode, I also wanted to talk a little bit about what’s happening in our TIP Mastermind community. So at the time of recording here on April 9th, we have 115 members. And, we’re approaching our hard cap of 150 members before we close the group.

[01:03:25] Clay Finck: I just had a call yesterday with a new member and I just continue to be surprised by the quality of members that we have joining. So primarily we’re seeing many entrepreneurs, high net worth individuals and portfolio managers joining the group as of late. And we also require members to apply to join just to ensure that the overall group quality remains high and we continually really want to raise the bar for the group overall.

[01:03:51] Clay Finck: And for those who aren’t familiar with the community, this is a place where we talk about stocks, we share ideas. And it’s a great opportunity to network with other like minded investors, especially if you’re interested in the types of discussions we had today talking about quality companies, or maybe even a value type opportunity.

[01:04:10] Clay Finck: And really, this idea came about because we are putting together. our live events in Omaha last year, and we just figured instead of just, getting like minded people together one weekend a year, why don’t we just create a community and do this online 365 days of the year? And I had mentioned that call I had yesterday with a new member.

[01:04:28] Clay Finck: This is with the lady who’s been in the. Investment industry for over 20 years, and she does some intense on the ground research on companies, global micro cap investors. She’s telling me she goes to the Philippines, India, all over Europe, and wherever she can find the best value. And it’s just amazing to have these types of people joining.

[01:04:51] Clay Finck: And then the other day, I also met just another really interesting member from Australia, and he’s yeah. Most certainly an entrepreneur at heart. He was working on using AI to help investors like you and I and our research and discovery process. And, using AI, it sounds almost a bit gimmicky, but he’s actually trying to build something that’s much more than just a chat bot that sends you cool responses that are very generic.

[01:05:15] Clay Finck: So along with developing as an investor, being a part of this community, I also really appreciate the opportunity to network with. Just extremely interesting and talented and just very driven people. Just, you meet these people and they, when you think about a growth mindset, like so many of these people just really embody that, I think.

[01:05:35] Clay Finck: And it’s also just a great place to potentially get new stock ideas for members. We have weekly live zoom calls and try to create these organic discussions and ways to interact with people. in the group and chat about investing. So just to give the audience a sense of some of the things we do.

[01:05:52] Clay Finck: For example, tomorrow, April 10th, you have a call on your quarterly portfolio update in a few days. We’re doing these breakout sessions to quickly meet new members. And then, next week, Joseph is also joining us for a Q and a session. and then in May 2024, we also have a couple of members of our community presenting individual companies.

[01:06:14] Clay Finck: So one is a research analyst from a big value firm out of New York city. He’s presenting MasterCard on May 8th. And then another member in the group that manages the fund, he’s going to be presenting MercadoLibre on May 15th. And I should also mention that many of our members understandably live very busy lives.

[01:06:33] Clay Finck: So we record every call that we do and have a whole library of 60 videos that you can go back and watch that we’ve put together over the last year. And it’s interesting the portfolio updates you do. We’ve been surprised by the level of interest. And those, and when I look at members, they really enjoy joining the calls and asking you questions and picking your brain on how you think about things.

[01:06:54] Clay Finck: And each quarter you essentially just share your portfolio, share the additions and the companies you may have sold during the quarter and your thought process on all of that. And you’re bringing in income. So presumably you continually have cash that you’re looking to put to work. So I was curious if you could speak to why you think others are so interested in this and how it maybe helps you in managing your portfolio.

[01:07:18] Kyle Grieve: Yeah, the portfolio updates have done really well on clay and it’s funny. So I’ve done a couple of them now. Stig did one as well. A private one, not on, TIP, but, and that was very well attended as well. And I think the main reason is just simply that. Community members really enjoy talking about stocks and strategy.

[01:07:35] Kyle Grieve: And when you break it down to my individual portfolio, you really get into the details of what I’m doing, why I’m doing it. And I think people just like learning from others and seeing if they can find some insights that maybe they can add, or maybe they can improve upon, a lot of people probably disagree with, maybe some things I do.

[01:07:55] Kyle Grieve: And so maybe they’re seeing mistakes that I’m making that they can hopefully try to avoid themselves. But I think that it just provides value because it’s something fun to talk about. People like talking about their portfolios and talk about the stocks they own, like getting updated on those stocks.

[01:08:09] Kyle Grieve: And so I try to do all that when I’m doing my updates. And then personally, I get a ton out of doing these portfolio updates simply because, before I joined TIP, I would just have my own companies and I’d be in my own little sphere. Obviously I tried to look at the downside, but it’s harder.

[01:08:25] Kyle Grieve: And when I have 115 other people looking at my decisions, I’m able to get all sorts of really cool perspectives that I couldn’t get myself. And It just really helps me learn more. Whenever you make an investment, you are making assumptions, right? And so one thing that’s been really interesting for me is that some of the community members will challenge my assumptions and not necessarily, to say I’m wrong or whatever, but just to get me thinking.

[01:08:50] Kyle Grieve: And I really appreciate it. yeah. For instance, on my upcoming update, there’s a member I know who’s going to come in. He’s a shareholder of both Dino Polska and Geronimo Martins, which is a parent company of Biedronka, which is a big competitor of Dino Polska. So he has some really good insights on Bedronka and also he lives in Europe, whereas I live in Canada.

[01:09:09] Kyle Grieve: he’s a little bit closer. And so he’ll, he’s going to share a bunch of these insights with me, and it’s really helpful because then I get to learn more about my competitors. And I love learning more about competitors because it helps me understand Polska better. And obviously, if there’s some reason for me to be concerned, I’d like to know what that is.

[01:09:23] Kyle Grieve: So that really helps. And then, on top of that, I also, I think yeah. A lot of the members appreciate how transparent we are. So I really try to rub my nose on my mistakes, just like Charlie Munger would say, I try not to hide anything. If I have everything that I sell, I talk about the portfolio update, talk about why I sold it.

[01:09:43] Kyle Grieve: I might, people can probably share in the pain of losing money if I’m selling one that lost money, but I don’t try to hide it. It’s part of investing. No one baths 100 and. As Buffett has pointed out, he’s right three or four percent of the time and look where he is now.

[01:09:56] Kyle Grieve: He’s been wrong a lot. So yeah, I really enjoy talking about my mistakes as well because it really ingrains them into my mind and helps me try to not make them again in the future. And I hope that the community members that come on and talk to me also learn from my mistakes so that they’re not making the same mistake that I was guilty of making.

[01:10:13] Clay Finck: What I also really like about the community is we have this dynamic where we have all these different people with different interests, different skill sets, different schedules, even. And I look at you, Stig, and I, for example, who are all very involved in the community. So taking me, for example, I hop on a call with every new member that joins the community.

[01:10:32] Clay Finck: And you also hop on calls with many members as well. And, when I do these calls, I often brainstorm, what types of things they would find value in and maybe what type of What are some ways they can contribute and add value to the group as well? Because, if you have a lot of people that just contribute, one writeup or one presentation a year, and you have a lot of people doing that, that’s a lot of people just helping each other and sharing with others.

[01:10:58] Clay Finck: It really adds up substantially over time. So I thought of one of the portfolio managers in the group, I thought he had a really interesting background. I personally wanted to learn more from him, how he invests. So I set up a call with him and the community in early June where we can. Talk about his background, how he got to where he is today.

[01:11:17] Clay Finck: And then, we’ll have a Q and a session at the end for members to ask questions. And when I look at you, you just love to dive into individual companies. You were just talking about one of your company’s competitors and managing your portfolio. So you can do things like, give a presentation on fundamental analysis or, do a call about your portfolio.

[01:11:36] Clay Finck: So it’s really cool to me, how. Everyone can have something to bring to the table and everyone really is just benefiting from that and we’re all in this journey of continuously learning, sharing and improving. it’s just really cool to be a part of. 

[01:11:53] Kyle Grieve: Yeah, absolutely. I think that the three of us bring all sorts of our own little specialties to the group and it really helps create value for the community and allows us to give some pretty cool high level attention to our members.

[01:12:03] Kyle Grieve: So I had a great chat with an Australian entrepreneur in the group who is in the building industry. And he was interested in a company that I presented and doing a one page write up. And so we were talking about some stuff and he had some really interesting questions that I felt I didn’t have a good enough grasp of and I want to learn more.

[01:12:19] Kyle Grieve: So I reached out to the CEO of Atlas, who I’ve met. So we had a great conversation and I asked him a bunch of questions that my member wanted to know more about. and then I’m just going to be chatting with him in a couple of days and telling him more about what we talked about and answering some of his questions.

[01:12:36] Kyle Grieve: It’s just really cool because, you can, you just find all sorts of different perspectives and ways of looking at things. And, because our community just keeps growing bigger and bigger, we are getting more and more people with these really diverse backgrounds. If I’m researching a business, it’s very likely that someone in the group has a lot of experience in that industry.

[01:12:59] Kyle Grieve: So like another example, I was just looking into the master group. I wrote a really long research for the community that was well received, and one of their members had reached out to me after reading it and told me that he had a lot of experience in the industry, specifically in North America, where matter is expanding to.

[01:13:16] Kyle Grieve: And he actually had been contemplating making a business that literally would have been a competitor to Mater. So he had a lot of really interesting insights into the business that I didn’t know about. And it was really cool learning from him. And then additionally, he literally just reached out to someone on LinkedIn who was a former employee of Mater and asked him a couple of questions and told me what he learned.

[01:13:36] Kyle Grieve: And that was incredibly helpful. So It’s just all these, seemingly small bits of information that we’re able to get and build relationships and they just provide exponential growth and learning for all the members of the community. 

[01:13:49] Clay Finck: Awesome. Thank you so much again for joining me, Kyle.

[01:13:53] Clay Finck: I always enjoy these quarterly deep dives on our best quality idea for this quarter. If the TIP mastermind community sounds interesting to you, you can check out our website to learn more. That’s theinvestorspodcast.com/mastermind. Also a link in the show notes, or, if you have questions, feel free to reach out to Kyle or I, my email is clay@theinvestorspodcast.com.

[01:14:16] Clay Finck: Kyle’s the mastermind. Kkyle@theinvestorspodcast.com. So with that, we’ll close out the episode there. Thanks so much for tuning in and I hope to see everyone again next week.

[01:14:27] Outro: Thank you for listening to TIP. Make sure to follow We Study Billionaires on your favorite podcast app and never miss out on episodes. To access our show notes, transcripts, or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only. Before making any decision, consult a professional. This show is copyrighted by The Investor’s Podcast Network. Written permission must be granted before syndication or rebroadcasting.


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