A Hidden Reason to Buy These 3 Stocks

Twenty-five years ago, British newsweekly The Economist invented "the Big Mac index." It was meant to be a fun, easy way to measure purchasing-power parity by comparing the price of a McDonald's Big Mac in different countries. It turned out to be not only fun and easy, but also quite accurate in predicting long-run movements in currency exchange rates.

Quirky economic indicators of all sorts have since propagated. Today, we'll examine one of the better known ones, "the lipstick index," and see what it tells us about three of the world's leading cosmetics companies.

When the going gets tough, the tough wear lipstick
The lipstick index posits that in uncertain economic times, a consumer will turn from more expensive indulgences, like a $500 handbag from Coach (NYSE: COH  ) , or $100 yoga pants from lululemon athletica (Nasdaq: LULU  ) , to cheaper ones, like $20 lipstick. The term was coined in the early 2000s by Leonard Lauder, then chairman of Estee Lauder (NYSE: EL  ) , who found that during tough economic times his lipstick sales went up.

Since lipstick sales aren't broken out individually for any of the companies we're going to look at, we'll instead examine overall company performance. To do so requires a corollary to the existing lipstick theory, i.e., if it's not lipstick consumers are buying, then it's foundation, eyeliner, lip gloss, etc.

If our modified theory holds, in this epic economic downturn, cosmetics companies should be going gangbusters, and therefore be good places to park your money. Let's start by going right to the source of the lipstick index, Estee Lauder.

1. Estee Lauder
Over the past three years, sales at Estee Lauder are up a shiny-red 20%, gross margin has increased from 74% to 78%, and profits have increased an iridescent 208%. Clearly, Estee Lauder is doing its bit to uphold the index.

2. Revlon
If Revlon (NYSE: REV  ) isn't experiencing quite the booming economic downturn Estee Lauder is, the company's performance is solid and keeping our index real. Sales are healthy, if a bit flat, hovering for the past three years in the $1.3 billion range.

Gross margins are strong and have increased, from 63.5% to 65.5%. But most importantly, operating profits have grown from $155 million to $199 million, for a glossy 29% uptick.

3. Cover Girl
Cover Girl is part of Procter & Gamble's (NYSE: PG  ) vast stable of consumer brands. While P&G doesn't break out numbers specifically for Cover Girl, it breaks numbers out for beauty. There, net sales growth was 3% for fiscal 2011, not exactly booming, but healthy, and in line with P&G's other business segments.

Estee Lauder, leading economist?
So all three of our cosmetics companies are doing well through this toughest of economic times. Does this prove the lipstick index infallible and absolute? No. These quirky economic indicators are meant to be guides, signposts that those of us without a doctorate in economics can read and possibly glean some useful information from.

But in the end, amid the fun and bad puns, you're left with three potential investments, companies that are currently holding their own, and more.

Fool contributor John Grgurich personally prefers lip gloss to lipstick, and owns no shares of any of the companies mentioned in this article. Motley Fool newsletter services have recommended buying shares of Procter & Gamble. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has an absolutely scintillating disclosure policy.

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  • Report this Comment On October 13, 2011, at 1:51 PM, MHedgeFundTrader wrote:

    My former employer, The Economist, once the ever tolerant editor of my flabby, disjointed, and juvenile prose (Thanks Peter and Marjorie), has released its “Big Mac” index of international currency valuations (click here for the link).

    Although initially launched as a joke three decades ago, I have followed it religiously and found it an amazingly accurate predictor of future economic success. The index counts the cost of McDonald’s (MCD) fat and sodium packed premium sandwich around the world, ranging from $7.20 in Norway to $1.78 in Argentina, and comes up with a measure of currency under and over valuation.

    What are its conclusions today? The Swiss franc, the Brazilian real, and the Euro are overvalued, while the Hong Kong dollar, the Chinese Yuan, and the Thai Baht are cheap. I couldn’t agree more with many of these conclusions. I am no longer the frequent consumer of Big Macs that I once was, as my metabolism has slowed to such an extent that in eating one, you might as well tape it to my ass. Better to use it as an economic forecasting tool, than a speedy lunch. And please hold the fries.

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