Lulu-lied!

The stock of Lululemon, the yoga-inspired, apparel company, has been on a tear since its summer IPO. While shares of the Canadian company have traded as high as $60, they have since settled to the low $40's. Lululemon still sports a $2.8 billion market capitalization -- not bad for a company with revenues of only $150 million and profits of just $7.7 million.

Enthusiasm for its brand imagery, unique fabrics and apparel design has been the key driver behind the company's rapid rise. An aggressive retail strategy is set to capitalize on the young company's loyal consumer following -- an expansion plan reminiscent of Starbucks in its early years.

Now, management is facing its first PR crisis and showing the strains of getting too much too soon. The focal point is a popular Lululemon clothing line called VitaSea, made from a cotton fabric with a one-quarter seaweed composition. Earlier this week, the New York Times reported that tests performed by an independent laboratory could find no trace of seaweed in the fabric. Founder and Chairman, Dennis Wilson, did not dispute the laboratory findings. link

Let's presume Lululemon did not intentionally mislead the public. Rather, this is most likely a case of sloppy management. A company spokesman admitted as much offering the excuse that Lululemon relied on its German fabric supplier, Smartfiber, to verify the VitaSea fabric composition and associated claims. This would be acceptable if it was not for the fact that VitaSea promotes revolutionary wellness benefits; "VitaSea reduces stress and provides anti-inflammatory, anti-bacterial, hydrating and detoxifying benefits". That's too much promotional copy to accept without demanding substantiation.

Don't short Lululemon stock just yet. Consumers seem unfazed by the controversy and the stock faced little downward pressure since the Times article. On the other hand, I would not load up your 401K with the stock either. Any company with a P/E ratio of 265 ought to have substance behind the hype to sustain its financial momentum. In comparison, public stocks trade at a P/E ratio of about 20 on average, indicating that the market supports a share price of 20 times its earnings. The fact that Lululemon trades at about 13 times greater than the average shows just how much Lululemon hype you need to believe before you should buy the stock.

Lululemon should pay close attention to its cultural "manifesto" to use its own words -- "That which matters the least should never give way to that which matters the most." Right now, growth and expansion matter the least and integrity matters the most.