Fast-growing cosmetics brand e.l.f. Beauty (ELF 2.04%) has more to prove the higher its stock climbs. Entering its latest business update on Nov. 1, the stock had pulled back in recent weeks but was still up 74% year to date. The shares fetch an expensive valuation, so investors will need to see outstanding growth from this company to justify the price of entry.
Let's look at e.l.f.'s recent performance and whether there is still enough growth left to justify buying the stock after its impressive run.
Growing brand awareness
In five years, e.l.f. Beauty stock has climbed over 700% over a lucky streak. The company knows its customers, what they want in their cosmetics, and how to advertise those products using social media. This largely explains its robust growth and soaring share price. In the fiscal second quarter ending in September, net sales grew 76% year over year -- its third consecutive quarter of 70%-plus revenue growth.
The company has enjoyed a strong tailwind in growing cosmetics sales over the last few years, but most importantly, e.l.f. is gaining market share against the beauty bellwethers, such as L'Oreal and Coty's Covergirl.
Management is keeping its finger hot on the trigger by leveraging its growing brand awareness to expand into more categories. It recently closed the acquisition of Naturium, a fast-growing brand that doubles e.l.f. Beauty's retail presence in skin care.
Expanding profit margin is a catalyst
The stock wouldn't be performing as well for investors if not for the company's ability to earn high margins on revenue. Stocks follow earnings in the long run, and e.l.f. has plenty.
Earnings per share more than doubled year over year in the quarter, and management's guidance calls for adjusted earnings to reach $2.47 to $2.50 in the current fiscal year, up from $1.66 last year. That's a year-over-year increase of 50% at the midpoint of guidance.
It's generally a rule of thumb that a growth stock trading at a price-to-earnings (P/E) ratio below the growth in earnings is a good deal. That is the case here, with e.l.f. Beauty's forward P/E at 36. If it can continue growing earnings at high rates, the stock could have a lot more upside.
The beauty company appears to have plenty of room to keep increasing its profit margin and fuel more earnings growth. In fact, e.l.f.'s profit margin has already improved from breakeven in 2019 to nearly 15% over the last year.
ELF Profit Margin data by YCharts.
In the last quarter, its gross profit margin improved by over 5 percentage points from inventory adjustments, cost savings, favorable shifts in sales to higher-margin products, lower transportation costs, and favorable currency exchange rates. Aside from the occasional swings in currency rates that can be a positive or negative, management has different levers it can pull to guide margins higher over the long term.
Why buy e.l.f. Beauty stock?
The biggest risk right now for the brand is dependency on fickle teenagers. But after several years of strong growth, this risk is fading every year that it continues to grow. e.l.f. is proving it knows how to innovate and release new products that can gain share against established beauty brands.
Another risk is the brand running out of room to grow fast enough to support its high valuation. Revenue and earnings are growing at high rates now, but how much more growth can this brand sustain over the long term?
I believe e.l.f. can sustain strong growth for several more years. International sales were up 157% in the last quarter, and management believes there's more opportunity ahead. The combination of international growth potential and expansion into new product categories should keep revenue growing at double-digit rates for several more years.
If you have a long-term perspective, the stock might be worth buying even at these highs. The shares have pulled back off the previous peak, so now could be a good time to consider buying shares if you see more growth for this cosmetics stock.
