I recently began rereading Peter Lynch's two investment classics, One Up on Wall Street, and Beating the Street. If you've never read these lively tomes, pick 'em up posthaste. If it's been a while, then consider giving them another go. They're worth it.
In Beating the Street, Lynch says, "As an investment strategy, hanging out at the mall is far superior to taking a stockbroker's advice on faith..."
That phrase stuck in my head, clinging like lichen. I'd read it before, but this time, it just echoed. So, I started looking around for mallish investments I hadn't ever considered.
It was around the 16th minute of waiting impatiently in line at the Clinique counter that a light bulb went off: Estee Lauder
You may be thinking, "But you waited impatiently for a long time, and yet you considered looking into the company as an investment? That makes no sense." Well, you probably don't understand the relationship between loyal customers and makeup. Let me spell it out for you.
I'm incredibly loyal to Clinique. I love its products and readily pay up for them. I grew up using the brand, and buddy, don't try to force me to buy anything else. I was going to wait in that line come hell or high water. My face needed its Dramatically Different Lotion, and nothing else would do.
And I'm hardly alone in my devotion. Ask any dedicated makeup shopper if she'd switch brands, and you're likely to get a look of horror.
When we discussed Estee Lauder recently, fellow Fool writer Bill Mann (who looks simply stunning in a rosy blush and tinted lip gloss) made an astute observation: Loyalty to high-end cosmetics perhaps only lags loyalty to cigarettes. He nailed it. About the only way you could convince me to stop using Clinique is if it were proven that the stuff's made from puppies. And even then, well, I ain't promising anything.The many faces of Estee Lauder
Estee Lauder benefits from that loyalty in spades. Apart from its namesake line and Clinique, it also houses Prescriptives, Bobbi Brown, MAC, Origins, Aveda, Stila, and Jane.
Whew. That list reads like a who's who of popular cosmetic brands. Not all of them are department store exclusive, either. Estee Lauder's done a good job of acquiring companies to expand its reach, as with the Jane line, which is inexpensive and teen-focused. Some of the brands -- primarily MAC, Origins, and Aveda -- have stand-alone stores, in addition to being sold through department stores. And Stila is an uber-trendy brand, hot among the hip.
Estee Lauder sells its cosmetics, skin care products, hair care products, and fragrances in more than 130 countries. The company's been around since 1946, and is still a family affair. The Lauders themselves control 90% of its voting rights.
But what about the numbers? I was curious, too, so I decided to run Estee Lauder through the Rule Maker's paces. We may have closed our real-money ports, but we still believe the strategies are valid. So let's check the criteria.
1. The company must have at least one sustainable competitive advantage. The more, the better.
If there's any doubt about this one, see above. It's all about the customers' brand loyalty, baby.
2. The company must be dominant in its given industry.
This one takes more consideration. Certainly, Estee Lauder has competition, such as French company L'Oreal and the American Revlon
3. The company has been dominant for more than a decade.
Yep. As mentioned previously, Estee Lauder was founded in 1946, and has been growing and adding to its empire ever since. That makes for more than a decade.
4. Cash King Margin in excess of 10%.
Oh dear. For fiscal 2002 (ended in June 2002), Estee Lauder's Cash King Margin was 7%. Close, but not quite there. For the first two quarters of fiscal 2003, the Cash King Margin is up to 11%, but that may be related to the business's seasonality.
5. Efficient working capital management, measured by a Foolish Flow Ratio below 1.25.
Estee Lauder barely misses here. Its Flow Ratio as of Dec. 31, 2002 stands at 1.29, not too far off the Rule Maker's guidelines.
6. Sales above $4 billion per year and growing revenues at 10%, plus rates.
Estee Lauder's sales have been above $4 billion a year since 1999, so that's not a problem. However, fiscal 2002's revenues only grew by 2% over 2001. And fiscal 2001's sales improved over 2000's by only 5%. The last time the company grew sales by 10% was in 2000. It's addressing this problem with lots of new products, and attributes much of the sales weakness to macroeconomic troubles.
7. Best-of-class management.
With Lauders occupying the chairmanship and several other top positions, it's hard to imagine them looting it for all its worth. Still, trustworthy doesn't necessarily translate into skill.
CEO Fred H. Langhammer has been with the company since 1975. He was COO from 1985 until 1999, president since 1995, and CEO since 2000. While he's held those various jobs, Estee Lauder has acquired some lucrative brands, but until sales growth picks up again, it's a stretch to call him "best of class."
8. Return on invested capital above 11%.
Estee Lauder falls a bit shy here, with an ROIC of 9%.
9. Cash no less than 1.5 times debt.
The company sticks this one, with cash 1.6 times total debt.
10. A reasonable purchase (or holding) price.
How does Estee Lauder stack up? At a P/E of about 35, given the rest of our discoveries, it's not terribly compelling. Many of the company's yummy-smelling fragrances and pretty lipsticks are compelling, though, and so I'll continue to frequent the Clinique counter while passing on shares.
Estee Lauder comes close in many respects to ascending Rule Makerdom, but it hasn't quite made it yet. Just goes to show why follow-through research is important. An idea may be generated at the mall, but it must be supported at home, 10-Ks in hand and a calculator nearby.