Making a Pretty Profit in Ugly Times

With many American consumers in such difficult straits that stocks of dollar stores have soared, you'd think beauty products would be discretionary to the point of obscurity these days. However, that's not necessarily the case. Some beauty stocks have done remarkably well.

Checking back in at the beauty aisle
Back in late 2010, Dayana Yochim and I made some bold calls in our "Stock Picks with Chicks" video series. In the beauty section of the consumer goods sector, we highlighted Estee Lauder (NYSE: EL  ) as a stock we believed was an attractive purchase. Conversely, we poked a bit of fun at Avon Products (NYSE: AVP  ) , but in entertaining ourselves -- er, attempting to entertain others, that is -- we were serious when we warned investors not to go there.

We were being pretty contrarian at the time. Estee Lauder could have looked like an overvalued stock to many investors; its market cap was a surprisingly high $15 billion. On the other hand, Avon looked like a beaten-down value that many investors speculated could find an acquirer.

However, it looks like our female investing intuitions were spot-on. Investors who bought and held Estee Lauder in early December 2010 have enjoyed a 62% total return.

Our bearish call on Avon has also panned out. Avon never did find a suitor, a potential deal with Coty fell through, and the company's even had the Securities & Exchange Commission probing it due to international bribery allegations. The shares have now lost 45% of their value since November 2010.

Losing face?
As we said at the time, despite hard economic times, the old adage that women will always buy a lipstick even if they can't afford other discretionary and indulgent purchases to raise their spirits seems to hold up to the test of time. Incidentally, that so-called "lipstick indicator" was coined by former Estee Lauder chairman Leonard Lauder.

High-end brands like the ones Estee Lauder provides as well as beauty stores like Ulta (Nasdaq: ULTA  ) , which distributes an array of specialty beauty products, have done much better than one might have suspected two years ago, given the poor economy.

NPD Group has reported that in the U.S. alone, sales of high-end beauty products increased 11% to $9.5 billion last year.

Although Estee Lauder trades at 21 times forward earnings, it's been firing on all cylinders and is obviously giving even fickle shoppers small pick-me-ups and little indulgences without breaking the bank.

Although Estee Lauder trades at a premium to, say, rival Elizabeth Arden (Nasdaq: RDEN  ) , which trades at 15 times forward earnings, I am far more confident in Estee Lauder's solid portfolio of strong brands that attract diverse demographics and strong profit margins to see it through. Revlon's (NYSE: REV  ) trading at just nine times forward earnings, but it's currently restructuring and cutting costs (and jobs) as it struggles financially.

As for Avon, I can find no indication that it's in any better shape than it was nearly two years ago. In the last 12 months, its revenue has dropped by 2.7%, and its profits are decelerating rapidly.

Sticking with the strong foundation
I currently have an "outperform" CAPScall on Estee Lauder and an "underperform" CAPScall on Avon in our community intelligence database, Motley Fool CAPS. You can see my track record here. It's tempting to take the positive points I've racked up on both CAPScalls and close out, but I've decided to stand pat. In my opinion, Estee Lauder's still a strong leader in the sector, and Avon's got far too many serious problems to reverse my opinion yet.

If you're searching for other attractive, high-quality stock ideas in the consumer space, be sure to check out our free report "3 Companies Ready to Rule Retail"; just click here for your free copy.

Alyce Lomax does not own shares of any of the companies mentioned. Motley Fool newsletter services have recommended buying shares of Ulta Salon. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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