Starting with Thanksgiving and on into Christmas, this holiday season will mark the first time since the onset of the pandemic that people are traveling and meeting in person with virtually no mandatory restrictions in place.
While individuals may still choose to mask or socially distance themselves from others, the majority of people seem to have moved on. Coupled with a workforce that's increasingly returned to the office, there is a groundswell of demand for cosmetics, beauty care products, and salon services.
It's why the beauty industry is one of the best-performing segments of the market -- and why Ulta Beauty (ULTA 0.13%), which is currently trading near all-time highs, ought to be on your investment radar.
Image source: Getty Images.
The power of personal interaction
The pandemic wrecked the retail market for those companies unlucky enough not to earn the distinction of being an "essential business." Lockdowns, remote work opportunities, and an inability to have face-to-face contact meant there was little need for makeup and grooming.
A reopened economy has changed that dynamic. Even with a potential recession looming in the new year, the industry is showing why it is considered resistant to such impacts. The Lipstick Effect should carry Ulta, Coty, Estée Lauder (EL 4.90%), and even Olaplex Holdings forward for some time to come.
Coined by Estée Lauder's Leonard Lauder, the Lipstick Effect was first defined during the market crash brought on by the dot-com bubble and 9/11 market collapse. It suggests companies like beauty care brands shine during times of trouble because consumers who can't afford actual luxury products instead turn to smaller indulgences like lipstick.
In fact, during the two-year period of 2009-2010, Ulta stock quadrupled in value (Estée Lauder shares jumped 171%) as sales soared 34% and profits nearly tripled. And year to date, Ulta's revenue is up 76% from the same period in 2020, while earnings per share have skyrocketed from $0.08 per share two years ago to $17.35 per share this year.
A stock that gets cheaper as it goes up
Although not a luxury brand, Ulta still commands significant pricing power, which has boosted its bottom line without affecting customer demand. Despite having raised prices this year to help offset the impact of inflation, same-store sales jumped almost 15% in the third quarter even though it enjoyed a near-26% rise last year.
That sort of consumer response allows Ulta to keep opening new stores without fear of cannibalizing existing-store sales or margins. The beauty care products retailer has opened 35 new locations so far in 2022, yet its gross margin increased by 160 basis points to 41.2% of sales compared to 39.6% last year.
Despite this growth, Ulta Beauty's valuation has remained grounded and in fact gotten cheaper over time. Though the stock has risen four-fold over the last decade, the retailer's price-to-earnings ratio has been cut in half, underscoring the power Ulta's earnings growth has on this business.
The ultimate recession stock
Ulta currently trades at 19 times next year's earnings estimates. Although Wall Street thinks it will grow earnings at a slower rate over the next five years than it did the previous five, this shows the beauty care retailer is actually reasonably priced.
The stock also trades for 25 times the free cash flow (FCF) it produces, which isn't a discount at all, but it's producing almost $1 billion of FCF on a trailing basis, a figure that's been steadily growing over time.
Ulta Beauty has proved it can perform in good times and bad, and that should brighten up any investor's portfolio.
