We Study Billionaires - The Investor’s Podcast Network - TIP627: Best Quality Idea Q2 2024 w/ Clay Finck & Kyle Grieve

Starting point is 00:00:00 You're listening to TIP. On today's episode, my co-host Kyle Greve 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. This quarter, we're going to be covering Lulu Lemon. Lulu Lemon is well known in the world of quality investors, as they have very impressive earnings growth in 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. 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. With that,

Starting point is 00:01:04 let's get right into today's episode on Lulu Lemon. You are listening to The Investors Podcast. 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 hosts, Clay Fink and Kyle Greve. Welcome to the Investors podcast. I'm your host. I'm your host. Clay Fink. And today I welcome back my co-host, Kyle Grief, for our Q2-20204 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. And for those not familiar, this is where Kyle and I take a look at our portfolios, take a look at our watch list,

Starting point is 00:02:01 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 Lulu Lemon. 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. So Lulu Lemon is quite an interesting company. I think it comes across many people's screens when they're looking at quality names and companies are quite familiar with. I'm sure many in the audience are familiar with this brand.

Starting point is 00:02:32 So for those who might not be as familiar with them, I'll dive into their background and their founding story and sort of what they do here. 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 and from my perspective from this trend to athlete leisure. So over the years, we've seen this trend towards people really valuing comfort and wearing something that's, comfortable yet stylish and less people are going to the office and wearing a suit or a dress and

Starting point is 00:03:12 whatnot or out in public people wear this type of stuff all the time. So a company like Lulu Lemon 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. It's been quite volatile lately after their 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 essentially all of this growth is entirely organic. So this means that they aren't making a ton of acquisitions along the way

Starting point is 00:03:54 to achieve this level of growth. So Lulu Lemon's 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, and then they're in a number of other different countries, to a lesser extent, the U.K., 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. 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 François Rochon looks to be the only one that I could find. I was looking at Datorama for some of this data. He has nearly a 3% position

Starting point is 00:04:42 in his fund and he added 1% in Q3 2020 during that pullback. And that looks to be the most recent time. He added a sizable stake according to Datorama. 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 Francois, Roshan the other day, and 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 believed in the long-term growth trajectory of the business. And I also mentioned that at the time of recording, Kyle and I do not own shares in Lulu Lemon. 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.

Starting point is 00:05:38 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. And he ended up selling this company in 1997 before starting Lulu. Lemon in 1998. Chip was the CEO of Lulu Lemon 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. So Chip really just has developed this passion and apparel, and he actually claims to have invented the vertical

Starting point is 00:06:18 retail niche. And selling clothing through retail stores is just incredibly difficult, and Chip has proven the ability to build a strong enduring business and just did a really fantastic job and getting the company off the ground and getting them going. You know, 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% of the company worth over $4 billion. And turning back to the product a bit here, Lulu Lemon is really well known for their yoga pants. I think, you know, many women would say that their pants are definitely comfortable, fashionable, and it's exactly. what a lot of women want.

Starting point is 00:06:56 And whenever I go to the gym or grow out in public, you see women everywhere wearing these. So it's definitely not something people are just wearing to their yoga classes and calling it a day. Lulu Lumin has certainly helped popularize this trend. And other brands have come out with similar products. 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.

Starting point is 00:07:25 especially Nike and Adidas, you know, athletes like you think of Michael Jordan, Tiger Woods. Lulu Lemon, 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. So Lulu Lemon 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 Lulu Lemon was better or different than the other options on the market. And another interesting stat I found is that Lulu Lemon still today caters very much to women. So brands like Nike and Adidas, they get two-thirds of their revenue from men, whereas Lulu Lemon is the exact opposite.

Starting point is 00:08:15 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. A key theme I continually saw in researching Lulu Lemon is that just their products are definitely higher quality than many of the other brands app there. 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. Who knows necessarily how true that is?

Starting point is 00:08:42 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. 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. Yeah, absolutely, Clay. So with Lou Lemon, it's competitive advantage is quite simple. It's the brand, right? Like you said, they have really high quality gear. It's kind of easy to identify.

Starting point is 00:09:21 when someone's wearing it. And the brand strength that they've built over time is, you know, it's 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. So he further breaks that down into two distinct sections,

Starting point is 00:09:44 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, like, Coca-Cola's entire premise is based on the product evoking a positive emotion from their customers, which is why their advertising has always been kind of geared towards, you know, 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. So, you know, for instance, I can go into a safe way and I can buy Coca-Cola or I can buy a compliments branded Coca-Cola.

Starting point is 00:10:24 And because Coca-Cola has this brand that is built up now over 100 years, it can charge a higher price than a competitor without losing any market share. So let's loop this back into Lulu Lemon. Lulu Lemon has been around since 1998. So, you know, obviously not quite the same tenure as Coca-Cola, but it's been around for a long time. And the brand is very strong. So, you know, it now has about 25 years of existence where it has built its strength inside the mind of its customers. So when we look at what is triggering the positive emotion in customers, I would attribute

Starting point is 00:10:54 that to probably, you know, about four different things. So one is product quality. Two is customer service. Three is the first mover advantage and athlete leisure that you kind of pointed out there. And then four is the community centered marketing. So I own quite a bit of Llemon, as does 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. But one of the

Starting point is 00:11:21 observations I had on Lul Lemon 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. You know, other shirts like, you know, I love Nike and stuff, but Nike stuff for a long period of time, it just falls apart. And, you know, Lulamon does doesn't do that. And the other thing I also like about it is that, you know, it doesn't get super loose over time. So that's kind of one of the competitive advantages. I think the quality of the garments have. So another thing that's cool about Lulu Lemon is their return policy. So just their customer service, they have this quality promise. Basically, something happens to your gear that,

Starting point is 00:11:59 you know, isn't due to normal wear and tear. You can take it in and they'll repair for you. So I actually did this. I had a set of pants from them had for about two years. And eventually I just got a hole in one of my pockets. And to be honest, it's probably my fault. 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 Lulu Lemon, zero questions asked. They, you know, gave me a little tag to come and told me they fix it. They'd give me a call after a few days. And they go, done. 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 ath leisure movement, this is a movement

Starting point is 00:12:39 towards wearing clothes that you can go to the gym or, you know, even go out and, you know, look reasonably nice in. So its clothes that both are comfortable and look good. And then another superpower the brand is its ability to simply leverage the community aspect to help increase brand awareness. So Clay kind of 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. 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%, and Under Armour at 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

Starting point is 00:13:24 than some of these other brands, but you'd be wrong on that assumption. 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 Lulu Lemon'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. So kind of dumping into that and looking at some of the ways they keep their costs down is number one, that ambassador program. So I kind of just talked about that. But they basically are partnering

Starting point is 00:14:01 with regular people and then just, you know, rewarding them not with money, but with product. And then these people obviously are well known in their communities or, you know, they might be 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 kind of spread the word and they get this organic growth from that. And then second, they have these community events. So they have marathons and other events where they have product giveaways as part of their sign-up. So I had a good friend of mine who in the summertime did this outdoor jog. I think it was on like Seymour Mountain where he signed up. It was

Starting point is 00:14:40 with Lul Lemon. You pay, you know, 100 bucks. You get to, you know, they time you and everything. And then they also just would, they gave them like a T-shirt. So that was pretty cool. And then obviously it gets you talking about that. He told me about it. So pretty cool little way they have to spread the word. So just another little point. I actually was an ambassador for Lulu-Lemen. So I owned a personal training business. And yeah, it was 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% off of gear. And basically all they did was they wanted me to tell them about what I thought about the gear. So, you know, what did I like about it or what did I not like about it?

Starting point is 00:15:18 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, you know, I obviously, I worked in a personal training setting so people would see what I was wearing. And, you know, that kind of leads off into their free advertising aspect. 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 can make this, you know, as comfortable as possible, as fashionable as he can make it. And there's a couple points related to what you're saying there. So at the top, you said that really, what sets them apart

Starting point is 00:16:05 is their brand. And when I think of Lulu Lemon, I sort of think of the status symbol aspect of it or what it signals when you're wearing Lulu Lemon. Chip was never big on like having a giant Lulu Lemon logo. But when you see the clothing, you can kind of tell what it is someone's wearing. So it kind of reminds me of like a Starbucks or an Apple here in the U.S. You know, 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. And that obviously gives companies like Lulu a pretty strong pricing power. And I also liked what you said

Starting point is 00:16:45 about the return policy. You know, just points to wanting to take good care of your customers. You know, many customers are more than happy to spend thousands of dollars a year at Lulu Lemon. And the lifetime value of a customer like that is just extraordinarily high. And I just really like to see companies like Lulu that just, you know, generally want to take really good care of their customers, you know, and give things like fixed products for free, essentially, and ensure 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.

Starting point is 00:17:19 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. So, you know, it seems like you can buy some things outside of their sort of ecosystem,

Starting point is 00:17:42 but they seem to be very mindful of where you can purchase their products. And because of this control they have over how they're prehistory. products are purchased, it also gives them a lot of control on how their brand is perceived and experienced by their customers. And in retailing, 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. 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

Starting point is 00:18:23 on how much staying power a company has, you know, especially in retail. A product 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. 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, Lulu Lemon has increased their revenues every single year. And they've had exceptionally high return on invested capital over that time period. 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%. And return on

Starting point is 00:19:10 capital employed is 46%. So Lulu Lemon 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, you know, 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. And I almost think of their brand, you know, 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. Yeah, exactly. And just wanted to rewind back to a point you brought up there about the vertical

Starting point is 00:19:50 market. So it's funny because if you look at a company like Nike, they've actually kind of stepped back. Like they've actually pulled their product off the shelves of some of their 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. So it just kind of goes to show you that, you know, it's not to say that Lou Lemon's business model is like 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 kind of moving in that exact same direction. So I like the other thing you mentioned was that I liked how sales can go

Starting point is 00:20:28 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, you know, That's a signal to its customers that maybe its apparel just isn't as valuable. Whereas a business like Lou Lemon, they don't have to do that. You know, yeah, they do have sales every now and then. But it's like Apple, right? You go and buy an Apple product.

Starting point is 00:20:55 It's like never on sale. And if you find it on sale, it's usually like less than 10% and you feel like you're really, really lucky. So, yeah, Lula Lemon 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 by it. So I just want to mention Hamilton Helmour one more time here. So part of looking at the

Starting point is 00:21:19 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 Lou Lemon has done an exceptional job, I think, of developing its brand over multiple decades now. And I think this further cements their barrier against incumbents. So athleisure, you know, it's 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 Lou Lemon does have this somewhat barrier to entry,

Starting point is 00:21:53 it shows that Lou Lemon is doing something right. So one way that we can look to see if Lou Lemon's doing something right versus competitors is just to look at their margins. So if we look at their gross margins, Lou Lemon'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. And in Lulu's case, that's only strengthened. So if you look at, if we go back in time at 2016, gross margins back then were

Starting point is 00:22:23 48% versus the 58% 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. So we could just use net margins for that case. So once again, Loule Lemon shines very bright here. So net margins for Lou Lemon are 16%. First less than 10% for Nike, Under Armour, and Adidas. So this means that when we run down an income statement, Lle Lemon is converting profits at just a much higher rate compared to some of these other super strong,

Starting point is 00:22:53 well-known athleisure brands. So you can make the argument that it's not the best comparison because these other brands aren't exclusively in athleisure. You know, they all sell shoes, for instance, and other types of sporting equipment where Lleleman doesn't, although Lleman does sell shoes, but it's a very small percent of its revenue right now. But I still think it shows the strength of Lleman's brand

Starting point is 00:23:13 when you compare them to some of these other businesses. So like Clay has already alluded to, Lou Lemon 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. One, pricing, two, the retail environment,

Starting point is 00:23:32 three, brand power, and four, the customer experience. So they don't rely on letting others sell their gear, which, you know, like I just kind of talked about with that Nike and Foot Locker example, it does compress your margins. So when you sell it all yourself, you're able to really, really protect your brand. And like all good brands, you want to reduce uncertainty. As I previously mentioned, you know, you don't want people buying Little Lemon pants and some people being really happy and then other people having their stuff fall apart after a day because then, you know, you're reducing that uncertainty. People want certainty.

Starting point is 00:24:01 And that's why they'll pay up for it. That's why, like 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, you know, it's very rare that they're going to be disappointed. So one way that Lulu does this is by having uniform stores. So Lou Lemon stores are all laid out very similarly. They have kind of a distinct vibe to them and they express a higher end product. So if you step into a store, you'll feel it yourself. You know, it's just, it's a really high quality experience.

Starting point is 00:24:26 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. And then, yeah, so, you know, when you shop at Lou Lemon, 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. You know, the customer service is the same. And only businesses that are selling its own product can really offer this advantage. If you look at Nike, for instance, if you were to go into a foot locker when they were holding their stuff versus, you know, a champs or a Nike store,

Starting point is 00:24:57 chances are that your customer experience is going to be different. And that kind of changes the way that your brand is seen in 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. So we'll be covering this in a little more detail later on. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord.

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Starting point is 00:29:49 or might even have more difficulty testing out different products or testing out different variations, whereas that wasn't an issue at all for Lulu Lemon. And I listened to the audiobook, Chip Wilson wrote this book called The Story of Lulu Lemon, and it started get me up to speed on your level of how well you know Lulu Lemon. And it was a good read to get a sense of what the company's all about and what his vision was from the beginning. 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 this skateboarding trend like he did with West Beach. And it was in 1998 when he started Lulu, he's like,

Starting point is 00:30:29 hey, I think yoga is still in his early innings. And he kind of 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 read of these stories, they're great because you get to hear this story of how the business was born, sort of the DNA. You get a sense of, you know, 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. And you really sort of gain an appreciation of what it takes to grow a multi-billion dollar company. It just, it sounds sort of 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

Starting point is 00:31:06 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. So it's this continuous iteration of, you know, 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 two women. So that's who he's getting feedback from and that's who a lot of these ambassadors are. So he really embraced innovation as a part of one of their core values. 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

Starting point is 00:31:46 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 $2.1 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 their store sales. Despite the in-stores sales continuing to grow at a fast clip, they're continuing to open new stores. So there's just so much tailwinds right now behind. the business. And 15 years ago, the e-commerce segment had barely existed. And then right after they went public, they actually released their e-commerce. And I think that's another example of Chipp,

Starting point is 00:32:30 sort of seeing where things were heading. He definitely wanted to control how the brand was viewed in the eyes of consumers. And he had to be really thoughtful in, you know, releasing that e-commerce segment because it's a much different ball game than having your own stores. And they just, again, they knocked the ball out of the ballpark on that one. And then I also wanted to touch on revenue by geography. 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% of revenue came from the U.S. 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,

Starting point is 00:33:12 they've just seen substantial growth. So today, nearly 12% of revenue comes from China. And again, And that segment's just growing very rapidly. It grew by over 60% 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.S. And then the e-commerce is also providing them a lot of growth as well. Yeah, so the growth along geographies has been great, as Clay pointed out,

Starting point is 00:33:42 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. 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 $20.6. So the three growth initiatives are one, product innovation, two, guest experience, and three, market expansion. So they're trailing 12 months, net revenues today are about $9.6 billion. So they look pretty much right on schedule compounding revenues around.

Starting point is 00:34:18 that's kind of 15% 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 Lulam and as Clay was just kind of talking about with Chip Wilson, like that was a really big part of the company and they've continued to do that. So 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, you know, 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. They're also dipping their toes in a footwear now as they offer a men's and women's shoes as well, but that's in its very infancy. So it's worth

Starting point is 00:34:58 noting that like Clay said, their sales are two-thirds to females and one-third to male. But this has grown from zero percent male share to where it is today, which is very impressive because it's been growing at a very fast pace. So when it comes to the guest experience, they're at the forefront of on my channel sales, which is simply that they have different sales channels that customers can buy their products from. So while their retail segment has been growing revenues at, you know, about 15% per annum for the last five years, Clay just mentioned it was 12% in the last year. So, you know, it's decent growth, nothing, you know, super spectacular. But when you look at their direct-to-consumer growth, which is like Clay also pointed out, which is essentially just

Starting point is 00:35:39 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 that the community angle that I already outlined. 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 when I was listening to a really good interview with Chip Wilson that he had with Tim Ferriss. 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

Starting point is 00:36:16 store in under 10 minutes with exactly what they wanted, then I was actually saving them $100 or $200 because I always came from that our customers were making $100 an hour who are 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 did hang 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. 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.

Starting point is 00:36:52 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, unquote. So these are just a good example of some of the very small details that Lou Lemon 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. 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, you know, North America is slowing down. It's also with noting that on menswear, they've done a very good job of growing this segment.

Starting point is 00:37:29 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. 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, it's $1.9 million. So they've nearly achieved that goal. They've tripled and they still have two years remaining on their initiative. So I think that they've executed at a very high level.

Starting point is 00:37:59 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 activeware market is massive. It's north of $350 billion. And Lulu Lemon only captures 2% of this market, despite them being a very big company today. But Lulu Lemon 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.

Starting point is 00:38:32 And they capture around 25 to 30% based on the data. that I was seeing on this. The active where market is very stable, very mature. It's growing at around 3 to 4% per year, so around the inflation rate. And the yoga market's growing a bit faster. It's growing at over 8% a year. So that's a nice little tailwind for Lulu Lemon being focused on that niche. And then when you look at the major competitors, we've talked about the legacy players,

Starting point is 00:38:56 Nike, Adidas, Under Armour. And then you have these premium brands sort of popping up that I feel like I see a new one every year that I've never seen before that are, you know, somewhat similar to Lulu, but maybe they're targeting a different type of customer, different type of products. So some of the players that I found were sweaty buddy, aloe yoga, fabletics, beyond yoga, public rec. And then a member of our mastermind community also mentioned to me Viori, 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, I've stated that this industry is very competitive and everyone knows that retail is

Starting point is 00:39:37 not an easy game to play. 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 athletic leisure. And as I've hosted the show for some time now, I've sort of 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, you know, this space is just way too competitive. And, you know, it is true.

Starting point is 00:40:13 It is really competitive. And there's a lot of players. But you can't overlook just how big this market is. 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% 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. And they still have the strong brand recognition.

Starting point is 00:40:41 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. 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

Starting point is 00:41:11 going the extra mile and creating that positive emotional response that you highlighted towards the beginning. And close to a certain extent are a commodity. And Chip realized this. He saw the skateboard and the surf brand. You know, it was just, he just saw how difficult it was to have a sustained, high-quality brand and so many of these types of segments just become commoditized. And I think that served as a strong lesson for him in building Lulu. And he knows that he needs to figure out a way to, well, 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.

Starting point is 00:41:47 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 you see with Lulu Lemon. and some of the things investors should watch out for with them. You know, a lot of kind 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. So one of the risks is like product assortment. So obviously, you know, with a lot of these retailers that are, you know,

Starting point is 00:42:16 creating products for specific seasons, you got to make sure that you have, you know, the right gear for the right season. And then the other thing that I find really interesting, especially about a company like Lou Lemon is, you know, they're really well known for their leggings. right and but they've diversified away from it but at the same time they've kind of they've still kind of stuck with you know their core products they know their leggings do really well so they've done a good job of kind of innovating and creating like adjacent products around you know the leggings

Starting point is 00:42:41 but they've also been well diversified you know making jackets and backpacks and other you know socks boxer briefs things like that so you know 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 got to maintain a level of excitement for your products. That's, you know, that just kind of comes down to, you know, making sure that your product is functional. And obviously, you know, Clay's pointed out multiple times that Chip Wilson was really into emphasizing that their gear was functional and works really well. And another thing that's really important for brands is obviously staying on top of your

Starting point is 00:43:17 customer's minds. If your customer's minds are transferring over to another product, well, chances are that it's going to be hard to get them back to focusing on yours. So that just kind of comes through advertising and they don't have to advertise on much, but you just see so many people wearing it. And it's pretty easy to identify that people are wearing it. So it's kind of the self reinforcing thing. But obviously, it is important to keep atop of customers' minds. 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 they get almost all of that from Taiwan. So, you know, if you're looking at specific risks, obviously there's always geopolitical tensions going on.

Starting point is 00:43:56 between China and Taiwan. So, you know, 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. You know, obviously China has been a huge growth lever for them. So if something were to happen with China and, you know, our relations with them went south, well, there's a chance that everything in China could go to zero. So, you know, I think those are kind of the biggest risks to pay attention to. Are there any others that you can think of, Clay? No, I think that about it's it. How about we turn to the management? Absolutely. So when we look at management, one thing that I like to look at, this is just kind of, you know, zooming out just in general is I like to look at management that is forward thinking and, you know, isn't just trying to look to Wall Street and tell them that next quarter is going to be good. I actually prefer someone who just is looking, you know, five years into the future. So I really like the fact that Lula Lemon 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, you

Starting point is 00:44:56 to kind of 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. 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, you know, 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, you look now, they don't talk about it at all. And that's a really, 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 Lulu Lemon had a five-year program. I can't remember the

Starting point is 00:45:35 exact date, but they smashed it. And basically, they had to come up with this new five-year program. I don't know how many years in advance, but basically, like, the five-year program, they smashed 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 Lulu Lemon is laser-focused on growth right now. New Store openings are growing at a five-year compound annual growth rate. of about 8.7%. They've gone from 491 to 711 stores. And these stores obviously cost money to open. So trailing 12-month capital expenditure is 6.8%. And if you contrast that with five years ago, still 6.8%. So we can probably continue to expect them to deploy capital into growth and maintenance

Starting point is 00:46:16 at probably that's 0.8% range. So if we look at fiscal 2023 depreciation and amortization was about $291 million, and they spent about $638 million on CAPEX. So, you know, 45% of CAPX is spent on growth and the rest on maintenance CAPX. So one thing that's cool about Lou Lemon, they have zero debt. They have a $400 million credit facility from 2021 that hasn't been drawn on yet. So 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 or non-current debt liabilities. So they're in a very strong position to continue growing without the need for debt or to issue

Starting point is 00:46:59 equity and obviously dilute shareholders. So super big strength of the business. I also like how they're keeping their, you know, it's been growing a little bit, but, you know, they're not like, you know, Berkshire that has whatever, I don't know, how much it's at now, $158 billion that they can't put to work. Obviously, Lou Lemon's a way smaller company. But, you know, it's nice to see that they can put their money to work and they're doing a really good job of that.

Starting point is 00:47:21 I want to just touch on inventory levels as well before we get back into management. But I think they're doing a really good job of managing their inventory. Inventory has grown at about 23% over the last decade versus about 21% in revenue. So I think they're doing a really good job of making sure 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, you know, aren't doing quite so good of a job. So yeah, and then just kind of 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. 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 0.1% of revenue, so super low.

Starting point is 00:48:04 And management is also on top of that. They've reduced 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 Lulamon's price of earnings was about 30 times or higher. So, you know, if we look at the yield on that, we're getting at most about 3.3% earnings yield. And, you know, obviously we've been in this ridiculously low interest world. So if you're comparing it to interest rates, well, 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 their ROIC has been in the last decade was 27%.

Starting point is 00:48:48 So, I mean, I don't know, you can make your own judgment call and whether you'd like to get the 3.3% from buybacks or just reinvesting in the company. So I wanted to move on now to manage your compensation. So they have an interesting plan where executives must retain a percent of their annual salary as shares in Lulam, which I like. The CEO must have five times their salary in shares and other executives must have three times. So they are allowed to include options, performance stock units, and reserve stock units in this number. But, you know, I like that. At least it kind of keeps the management somewhat aligned with shareholders. Base salary for executives is reasonable.

Starting point is 00:49:27 So the CEO Cal of McDonald had a base salary of $1.3 million. Other named executives are between 700,900K. This seemed to be somewhat aligned with competitors like Nike. So the options plan is very lucrative, though, for example. X and Lle-Ele-Eleman. So Cald McDonald has received a total compensation of 10.6 million in 2020, 11.3 million in 2021 and 15.6 million in 2022. 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.

Starting point is 00:50:07 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. So the profit incentives also can be bad for certain businesses. But in my opinion, it actually does make really good sense for Lue Lemon. So the reason that earnings incentives can be bad. It's kind of similar to shareholder return. You can basically just spend a bunch of money by a company that has a bunch of earnings and then just bolt that onto your business.

Starting point is 00:50:46 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 it makes sense for Lulu Lemon is that they're not an acquisitive company. As Clay pointed out earlier, it's all their growth is organic growth. They're not having to buy other things. They have gone in and bought a few.

Starting point is 00:51:06 things that I will mention, but they've been very small. So, you know, overall, the incentive program is, I think it works well for the company. And then also the, if you look at Lou Lemon's operating margins over time, they've done really well. And I think that's probably part of the reason that, you know, 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 then net margins in 2015 were 13 percent. And today, they're 16 percent. So you're seeing a really nice gain in there. And that's probably partly driven by the incentive program of management. So 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

Starting point is 00:51:47 yellow flag, but there's about 693,000 shares that are owned by executives and directors as a group, and that's include the options. So this only represents about 0.5% of diluted shares outstanding. As Clay pointed out, the founder Chip Wilson still owns about 8.5% of the shares outstanding, but it is worth noting, you know, he's not part of the business anymore. He's, you know, he's not on the board or anything like that or making decisions. So I think it is worth it, though, to look at how much as a percent of shares that, you know, the CEO has as a present of his net worth. So I use something called Walmine, which is the site.

Starting point is 00:52:21 And it said that the CEO, Calvin McDonald's net worth was around 50 million. This was in the end of 2023. And they said that he also owned about $38 million of LULU stock at that time. So that means about 76% of his net worth is. in Lululemon stock, which I think is pretty good alignment. And now if we look back at Cala McDonald's track record as the CEO of Lulmin, it's been really good. So he took over in August of 2018. And from then until today, he's compounded a Lululemon's share price at 18.3%. If we look at just how much he's grown earnings per share, he's achieved a 36.3% kegger. So I think he's doing a very good job on that

Starting point is 00:52:59 front. And then another metric that I like to use that I stole from Buffett 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. 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 Lill Lemon, they've created $12.13 of value for shareholders. So that's very good. 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,

Starting point is 00:53:36 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. So, you know, 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 this job with Lula Lemon. Then another thing, obviously, with CEOs, I just like to make sure I'd, delineate between if there are types of CEOs that really love attention or if they just avoid attention. So Calvin's appeared on CNBC and a few podcast episodes. It's not a lot, but it's just

Starting point is 00:54:10 something to observe. So he's not a recluse by any means, but I don't think he's wasting too much time on doing public relations. And then just the final thing I wanted to mention, I did mention about mergers and acquisitions, is they actually have had one acquisition. So this was the mirror. So you might have seen ads or seen this talked about kind of 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 would kind of acted as like a giant iPad where you could just do exercise in front of it. 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.

Starting point is 00:54:50 And so Lou Lemon 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 $72.1 million. So, you know, 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

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Starting point is 00:58:49 All right. Back to the show. 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. 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 with Joseph Sheposhnik. 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.

Starting point is 00:59:19 he pointed to a statistic on, you know, 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 Poo-Lock-Prasad's point that these quality businesses, they're able to take some of these risks and take, you know, maybe go out and make an acquisition. And it's just the core business, it doesn't affect it at all. You know, the business is turning along just as it always has. And, you know, 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. So I wanted to turn here to valuation in capital allocation. I'll try and keep it as simple as possible. It's hard not to mention too many numbers when talking valuation, but given my love for numbers, sometimes I just can't help myself. So I At the time of recording, the stock's actually traded down from their recent quarterly results, and that's kind of how I got brought up on my radar.

Starting point is 01:00:23 And some of the people I follow, I've shared writeups on Lulu. So it's pretty funny how a lot of people in our circles have kind of been attracted to this quality name. And yeah, sometimes, you know, if a company has return on invested capital, 40%, it's down from over 500 to 360. You know, that catches a lot of people's attention. At the end of 2023, yeah, like I mentioned, the stock was over 500. it's down 30% from its high. 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 quarter, they opened 25 new stores. So they're continuing to expand their footprint there. And when we look at the multiples for Lulu,

Starting point is 01:01:07 seems to be attractive relative to where it's been historically. The EV to EBIT, for example, now sits around 20. So 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 of being closed for a period. Just prior to COVID, this multiple, just for a reference, was 38. And ever since 2022, we've really seen it sort of 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 Lulu Lemons.

Starting point is 01:01:47 And I think we could also argue that Lulu Lemon is a higher quality business, but that's discussion for another day. And I don't think the stock is drastically overvalued looking at, you know, the company's return prospects, their growth prospects, and how they're reinvesting. So I like to look at, you know, what is a company doing with their current earnings? And then how is that going to affect their future growth and revenue and earnings? 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 CAPX is something we have to estimate ourselves as investors. So that company has their capital expenditures and we have to estimate some portion of that's for growth. 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

Starting point is 01:02:52 is being allocated towards capital expenditures, maintenance and growth. And a lot of the cash flow is also going towards sharey purchases. I think some more conservative investors might like that capital being returned to them, but some could also argue that, you know, it's, when the stock starts trading up, it's probably not great for them to, you know, be doing repurchases, because, you know, maybe they could distribute the dividend. You know, it's hard to expect a company like this to reinvest 100% of their cash flows. It's just really difficult to do. And I also like to see just like stable, conservative growth over time, too. So, yeah, some investors probably like the buyback. Others might not like it as much. And then,

Starting point is 01:03:34 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. 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 stock runs back up and gets to elevated levels.

Starting point is 01:03:58 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. And then the e-commerce segment continues to grow at a healthy clip. I personally expect to return something like 12 to 15%. Generally, this company is underpromised 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. 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. I mean, year after year, it's just been a strong outperformer. And it's at what I would argue, a reasonable valuation today.

Starting point is 01:04:38 I have no reason to believe that that strong outperformance won't continue. And this is a stock that's had, it's 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, you know, have pretty good returns if you're a more opportunistic investor. And, you know, on the flip side, if we look at the potential downside, we see the slow revenue growth 15 or 16% in the recent quarter. A year ago, revenue growth rate was 30%. So they, again, they got a big boost from COVID and they're seeing slowing growth in the U.S. and management

Starting point is 01:05:13 guides for revenue growth of around 11 to 12% in fiscal year 2024. But they still expect revenue to grow at 15% over the longer terms. You know, retail's a bit cyclical and they expect 15% growth over the next five plus years. Again, they tend to over deliver and the share price drop might be a good opportunity to investors that, you know, want to get into more of like a blue chip, 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% per year. And that's while they're doing, you know, a lot of buybacks. They're not having to reinvest a hundred percent of

Starting point is 01:05:56 their capital to achieve that exceptional growth. And yeah, yeah, that growth in free cash flow is, led to the stock being a strong compounder. Yeah, Clay, I agree. I think your valuation assumptions are all sound very reasonable and conservative with kind of an embedded margin of safety into those numbers. With that assumption that you are making 12 to 15% 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.

Starting point is 01:06:23 If we look at part of the life cycle that Lulu Lemon is in, they're still in growth stage, but they also have embedded competitive advantages. So, you know, they're still reinvesting capital back into the business at, you know, 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 kind of be forced to 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, you know, 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

Starting point is 01:07:02 if they're going to pump more and more money into the business and that's why they're redistributing it. So right now, I really like the balance of the business being, you know, 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 did own Llemon, I don't. I like to keep track of key performance indicators, KPI's. So for Llemon, if I was 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.

Starting point is 01:07:33 But essentially I would just obviously if it could keep growing, that would be great. But given how high it is, if they can just maintain it or even if it dropped a little bit and they just maintained that number, I would 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 starting to erode. And that would be something that you need to pay very close attention to. kind of on the same front looking quantitatively.

Starting point is 01:08:00 If we look at, you know, things like net margins and free cash flow margins, we want to see obviously in a perfect world, it would be awesome if they could continue increasing those. They can't keep increasing it, you know, into infinity, otherwise become 100% and that's not going to happen. But, you know, just going from, I think, you know, I mentioned earlier that net margin gone from 13% to about 16% from 2015 to today. You know, it's only 3% difference, but that adds a lot of value to the business.

Starting point is 01:08:24 So, you know, 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 a pretty good KPI to watch to make sure that their competitive advantages are being maintained. I would definitely pay a lot of attention to their growth, especially outside of North America. We know North America is, you know, now it's kind of getting into that more mature base. It's still growing at a really nice rate, but, you know, you're not going to see it growing. at the same rates that it has in history and you're not going to see it grow at the same rates that the China and the rest of the world is going to be growing at. So I would definitely be paying

Starting point is 01:09:02 attention to how those things are growing specifically because if you are buying this to get growth, then that's kind of going to be one of the bigger growth drivers. I would also be paying attention to men's product revenue. We know that, you know, they've grown that from zero to a third of their revenue today. So, you know, will it ever be 50 percent? I don't know. Probably not. I just think that with the DNA of the company kind of embedded in women's wear, it probably always skewed to that. But could it go to 40% or 45%? I don't know, maybe. And obviously that would provide a lot of value for shareholders. Store account. So this is kind of 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 because you're going to be making more money.

Starting point is 01:09:44 Another thing also that's really interesting just for these kind of omni-channel businesses is that sometimes, you know, someone might go into a little lemon, not feel like buying anything, but just go there to try stuff on. That gets the brand name into the top of their mind. Maybe a little, a couple days later, they think about it. 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 get more foot traffic and more people talking about your product. And then lastly, I kind of just talked about the DTC or the e-commerce segment, it's growing insanely fast, and that's going to be a huge growth driver. So you definitely would want to see that business is continuing to grow at

Starting point is 01:10:23 high rates. Thank you for mentioning the KPIs there, Kyle. I can't remember where I've read it, but I believe I've read that Nike's business in China is 10x size of Lulu Lemon. So presumably, there's a long runway in China especially. So that wraps our discussion on Lulu Lemon. 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. 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,

Starting point is 01:11:13 and portfolio managers joining the group as of late. And we also require members to apply to join just to ensure the overall group quality remains high. And we continually really want to raise the bar for the group overall. And for those who aren't familiar with the community, this is a place where we talk stocks, we share ideas. And it's a great just opportunity to network with other like-minded investors, especially if you're interested in the types of discussions we had today are talking about quality companies or maybe even a value type opportunity. And really this idea came about because we were

Starting point is 01:11:49 putting together our live events in Omaha last year. And we just figured instead of just, you know, getting like-minded people together one week in 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. This is with a lady who's been in the investment industry for over 20 years. And she does like some intense on the ground research on companies, global microcap investor. 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. And then the other day, I also met just another really interesting member from Australia. And he's most certainly an entrepreneur at heart. He was working on

Starting point is 01:12:36 using AI to help investors like you and I in 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. 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. You know, 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. And it's also just a great place to potentially get new stock ideas for members. You know, we have weekly live Zoom calls and try and create these organic discussions and ways

Starting point is 01:13:21 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, 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 Sheposhenik is also joining us for a Q&A session. And then in May, 2024, we also have a couple of members of our community presenting individual companies. So one is a research analyst from a big value firm at a New York City. He's presenting MasterCard on May 8th. And then another member in the group that manages a fund, he's going to be presenting Ricardo Libre on May 15th.

Starting point is 01:14:04 And I should also mention that many of our members, understandably, live very busy lives. So we record every call that we do and, you know, 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 in those. And when I look at members, you know, they really enjoy joining the calls and asking you questions and picking your brain on how you think about things. 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.

Starting point is 01:14:40 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. Yeah, the portfolio updates have done really well, 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 that was very well attended as well.

Starting point is 01:15:05 And I think the main reason is just simply that community members really enjoy talking about stocks and strategy. And when you kind of 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. You know, a lot of people probably disagree with, you know, maybe some things I do. And so maybe they're seeing mistake 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 talk about their portfolios and like talk about the stocks they own, like getting updated on those stocks. And so I try to do all that when I'm doing my updates. And then I personally,

Starting point is 01:15:49 I get a ton out of doing these portfolio updates simply because, you know, before I joined TIP, I would just have my own companies and I'd be in my own little sphere. You know, obviously I tried to look at the downside, but it's harder. And when I have like 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. I mean, 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, you know, to say I'm wrong or whatever, but just to get me thinking and I really, really appreciate it.

Starting point is 01:16:27 So for instance, on my upcoming update, there's a member I know who's going to come and he's a shareholder of both Dino Polska and Geronimo, Martins, which is a parent company at Bedronka, 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. So, you know, he's a little bit closer. And so 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.

Starting point is 01:16:52 And I love learning more about competitors because it helps me understand Dino Polska better. And obviously, if there's some reason for me to be concerned, I like to know what that is. So that really helps. And then, you know, on top of that, I also, I think 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. You know, I try not to hide anything. If I have everything that I sell, I talk about on the portfolio update, talk about why I sold it. You know, I might, people can probably share in the pain of losing money if I'm selling one that lost money. But

Starting point is 01:17:24 I don't try to hide it. It's, you know, it's part of investing. No one bats 100. And, you know, as Buffett has pointed out, he's right three or four percent of the time and look where he is now. 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 help 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. What I also really like about the community is we have sort of this dynamic where we have

Starting point is 01:17:54 all these different people with different interests, different skill sets, different schedules, even. And like 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. 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 are some ways they can contribute and add value to the group as well? Because, you know, if you have a lot of people that just, you know, contribute, you know, one write-up or one presentation a year. And you have a lot of people doing that, you know, that's a lot of people just helping each other and sharing with others. And it really

Starting point is 01:18:35 adds up substantially over time. So I thought of a 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 in the community in early June where we can talk about his background, how he got to where he is today. And then we'll have a Q&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're just talking about one of your company's competitors and managing your portfolio. So you can do things like, you know, give a presentation on fundamental analysis or do a call about your portfolio. So it's really cool to me, you know, how everyone can sort of

Starting point is 01:19:17 has something to bring to the table. And everyone really is just benefiting that. And we're all in this journey of continuously learning, sharing and improving. It's just really, really cool to be a part of. Yeah, absolutely. I think that, you know, 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. So I had a great chat with an Australian entrepreneur in the group who is in the building

Starting point is 01:19:44 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. he had some really interesting questions that I felt I didn't have a good enough grasp of and I wanted to learn more. So I reached out to the CEO of Atlas, who I've met. So, and we had a great conversation and I asked a bunch of questions that my member wanted to know more about. And, 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. So it's just really cool because,

Starting point is 01:20:13 you know, you can just find all sorts of different perspectives and ways of looking at things. And because our community just keeps growing bigger and bigger, we're getting more and more people with these really diverse backgrounds. So, you know, if I'm researching a business, it's very likely that someone in the group has, you know, a lot of experience in that industry. So like another example, I was just looking into Mater 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 he reading it and told me that he had a lot of experience in the, the O&G industry, specifically in North America, where Mader is expanding to. And he actually had been contemplating, making a business that literally would have been a competitor to Mader. So

Starting point is 01:20:59 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 and that was incredibly helpful. So it's just all these seemingly small bits of information that we're able to get and building relationships. And they just provide exponential growth and learning for all the members of the community. Awesome. Well, uh, thank you so much again for joining me, Kyle.

Starting point is 01:21:29 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 the investors podcast.com slash 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 at the Investorspodcast.com. Kyle's is Kyle at the Investorspodcast.com.

Starting point is 01:21:56 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. 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 quotes. courses, go to theinvestorspodcast.com. This show is for entertainment purposes only, before making any

Starting point is 01:22:22 decision consult a professional. This show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP627: Best Quality Idea Q2 2024 w/ Clay Finck & Kyle Grieve

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