The stock is down, creating a real bargain opportunity.
Investing isn’t always rational. It seems logical that you’d want to buy a stock that’s climbing. That implies it’s doing well and that there’s reason to be confident in its future potential. Sometimes, this is the way to go.
But if a stock is already demonstrating high gains, that could indicate it’s reached a peak. Conversely, stocks that are tanking could be the key to investing success with a rebound. It could be a risky strategy unless there are valid reasons to believe it could stage a strong comeback.
When a stock with every reason to outperform is tanking, that’s an opportunity. Ulta Beauty (ULTA -0.43%) is a fantastic stock that typically beats the market and has incredible future potential, but it’s down 19% this year. Here are three reasons to buy it hand over fist right now.
1. The differentiated model
Ulta has built itself into a powerhouse cosmetics business by breaking all of the rules. It brings together luxury and mass brands, whereas the traditional setup divided those two segments into completely different markets. Ulta’s management recognized that the core “beauty” enthusiast shops from both of these segments, and that offering them altogether under one roof was an untapped opportunity. It says that 66% of buyers are these enthusiasts, and they account for 83% of total sales.
Another way it stands out is that it offers services. Other brands all operate similar models: Luxury brands are carried in department stores, and mass brands are sold in pharmacies and supermarkets. Many brands have direct-to-consumer physical stores, a recent development in the world of cosmetics, and today most brands also have digital direct-to-consumer channels. None of these setups are conducive to offering services the way Ulta’s large stores are, and services are a key element of its model. People who come in for services, like hair or nail design, are much more likely to also walk out with products. It’s a flywheel effect that leads to greater loyalty and higher sales.
Today, Ulta carries hundreds of brands across demographics, in addition to its own brands, to tap into this customer, and loyal beauty spenders are its main market. Ulta has 1,375 stores across the country, and it’s has launched a successful rollout of stores-within-stores at select Target locations.
It had 43 million members at the end of 2023, an increase of 3 million over 2022, and these members account for an incredible 95% of sales. That provides Ulta with tremendous data to use in creation of its agenda and the ability to understand and meet demand.
2. Don’t mistake its profitability
One of the factors that have led to Ulta stock’s decline is a pressured operating margin. Ulta is feeling inflationary pressure in a number of ways; sales crept up 3.5% up from $2.6 billion last year to $2.7 billion this year in the 2024 fiscal first quarter, ended May 4, with a 1.6% increase in comparable sales. Earnings per share (EPS) fell from $6.88 last year to $6.47 this year, and operating margin dropped from 16.8% to 14.7%. Management lowered its outlook across the board.
It’s important to keep in mind that Ulta carries zero debt and generates steady free cash flow. These are positive qualities that mean it’s in no financial danger and is operating efficiently. The drop in profitability is an outcome of external factors, and the company is rolling through a challenging time.
All companies will face challenges at different points in time. Investors shouldn’t panic sell because of a difficult quarter–or even several. If the investing thesis is intact, and management is effectively dealing with short-term hiccups, hanging on will reward you in the end.
For new investors, the challenges can create a buying opportunity. Read on.
3. The dirt cheap price
At the current price, Ulta trades at a dirt cheap forward 1-year price-to-earnings multiple of under 14. That’s a bargain when put into the context of Ulta’s potential.
This is the principle behind value investing. Value investors look for stocks that could be undervalued and will likely rise to meet their real value.
Ulta is a well-run company with a long-term competitive advantage in its differentiated model that targets the beauty enthusiast. It’s trading at a discount, and now is an excellent time to buy shares.
Jennifer Saibil has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Target and Ulta Beauty. The Motley Fool has a disclosure policy.
