Estée Lauder (NYSE:EL) stock has surged 80% over the last 12 months, and management has clearly cited several of the reasons for the company's strong momentum.

For starters, the company employs a disciplined financial model which keeps incremental sales dollars flowing to the bottom line. In this segment from Industry Focus: Consumer Goods, Vincent Shen and senior Motley Fool contributor Asit Sharma look at Estée Lauder's latest financial results and explain what makes it such a consistently profitable (and growing) enterprise.

A full transcript follows the video.

This video was recorded on April 10, 2018.

Vincent Shen: Let's dedicate a couple of minutes now to their most recent results for this part of the show. Estée Lauder has reported, I think, the first half of its current fiscal year so far. The highlights seem to be an accelerating top line and earnings growth in double digits. Then, their guidance, I believe, has already been revised upward more than once so far in this fiscal year. So, pretty impressive. What are we looking at exactly here?

Asit Sharma: The financial model for Estée Lauder is really intriguing to me. Vince, you mentioned trailing 12-month sales of about $13 billion. In the last fiscal year, the company sold closer to $12 billion, if you look at their reporting year. Extremely high gross margins for Estée Lauder. They tend to run at around 80%, quarter after quarter. That's not necessarily an indication of how profitable its manufacturing process is. That is an indication of these high price points it can sell its product at. To accompany that high gross margin is a high general and administrative cost and a high selling cost. That takes up about 60% of each sales dollar.

If we look at the close to $12 billion that the company sold in the last fiscal year, it made a gross profit of $9.4 billion. Now, out of that $9.4 billion, Estée Lauder spent nearly $3 billion in advertising, merchandising, sampling, promotion and product development. So, you can see what it's doing. It's selling product at a very high price point, that aspirational price point, and it's taking some of that gross profit and just pouring it in to getting the product in front of people. What this generates at the end of the day is a pretty reliable 10% net profit margin, year after year. So, it's a stable business with a very stable structure in how it makes each sales dollar and each profit dollar. And for the past few years, it's been growing sales at a good clip, 4-5%.

Now, what's happened in the last year is pretty amazing. Cumulative revenue growth in the first six months of this fiscal year are up 16% to $7 billion. So that is a leap, really, from what the company has historically been able to generate. It's had to revise its full-year forecast twice already this year. The company now expects full-year growth for this year of 10-11%, and that's because it will have a weaker third and fourth quarter this year.

I wanted to flip it back to you, Vince. Let's talk about this growth and what's driving it.

Shen: Yeah, sure. I'll add also, for investors who want to look it up a little bit further, management has mentioned that in the next three years, they expect revenue to grow 6-8% annually, while earnings continue to go up double digits. They also think that their profitability can continue to improve with their operating margin, for example, expanding about 0.5% each year. So, management does offer a little bit further outlook, in terms of some of that guidance.

But, the big things that we wanted to focus on are the sources of that strength. Company management has pointed to several specific elements. The ones that they seem to call out the most clearly are China. That is what the CEO believes is the largest opportunity long-term. Then, there is travel retail, which we've touched on briefly, the online channel, and then the Estée Lauder namesake brand itself.

Let's look at China first. Growth in that region has easily been in the double digits, and what they've seen is that young consumers there are very, very passionate about prestige beauty, which obviously fits beautifully with this company's focus and business model. The thing is, Chinese consumers are transitioning from what was previously a focus on skin care to also some of the other categories that the company offers, like makeup and fragrances. The CEO describes it as going from tapping just one engine in the Estée Lauder business to a multi-engine model for this market. In the last quarter, that's their fiscal 2018 second quarter, they said that the Chinese makeup business doubled. The online business in that region also doubled, and now it's over 25% of sales as of that second quarter.

Otherwise, they are also working to balance a physical and digital footprint in that region. For example, the company will use data from their online purchases to determine which cities to enter. But the namesake Estée Lauder brand already has a physical presence in 170 of the higher-traffic cities in China, but there's still 600 more that they can reach online and use that data to determine where else to expand to. The big thing in terms of consumer habits that I thought would be interesting to point out, which was really surprising, was Chinese consumers will often use up to seven or eight skin care products per day. So, as the company builds customer loyalty, they further penetrate into the available product categories in that market, the growth accelerates even more quickly because of that kind of usage. So, really big opportunity there for the company.

Another one of the pillars is their online sales. What is the company seeing there? What stood out to you, Asit?

Sharma: The company has this unusual, savvy ability to go into a region and figure out the best way to market itself online. You mentioned social media influencers, Vince. That's very big for Estée Lauder. Their mobile base sales in the most recent quarter rose 70%. One of the things that distinguishes Estée Lauder from some of the other huge conglomerates that I look at is, they really understand where and when to sell. For example, there's a huge holiday in China called Singles Day, which happens every November 11th. And the better companies in China, those that are really great at marketing, fully take advantage of this holiday, and that's something that Estée Lauder has really jumped on. They also understand that it's important to be on places like Tmall, which is an online shopping venue in China, and they're really selling ferociously through that channel.

One of the things that you see that's the confluence of both of these trends is this travel retail. Often, consumers will learn about some of these aspirational brands within the company's portfolio within an area through an online channel, and then when they travel, they can buy those products. They aren't always available in specific regions in China. And Vince, as you mentioned, they're in 170 cities physically, they sell to another 480 cities in China online. So, if you're a Chinese consumer, you may not have any retail presence that you can physically go to, but you learn about these brands, and when you travel to other Chinese cities or you travel abroad, that's the point at which you make that purchase.

There's one more thing that I found very insightful about the way the company has been able to sustain its growth, and that is, it pays attention to its flagship brands. The brands of Estée Lauder, Clinique and MAC, together as a group, grew by double digits in this second fiscal quarter. And that is really impressive, because the Estée Lauder brand, of course, has been around for decades. I wanted to read one thing that the CEO, Fabrizio Freda, said in his most recent earnings call, which speaks to this. "Estée Lauder is a prime example of a heritage brand benefiting from continued consumer loyalty as it successfully innovates around its core products and engages consumers in modern ways. Although we continue to face strong competition or trial from upstart and indie brands, we believe many of them won't have the staying power and repurchase rate of our established brands and core product. Trial is often an investment."

So, in the end there, he's speaking about this idea of getting product into the hands of consumers, often free. So, they try it and then continue to buy it. But, the amount of investment the company makes in its leading brands is impressive, and the fact that they're able to keep growing these flagship brands, which are older than I am, in the double digits, is simply amazing.

Asit Sharma has no position in any of the stocks mentioned. Vincent Shen has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.