Buffett Invests in Beauty Stocks After 33% Drop: Is Now the Time to Buy?

In a surprising move, Warren Buffett has added a cosmetics retailer The ultimate beauty (ULTA -0.04%) TO Berkshire Hathawayhis portfolio in the second quarter. Buffett is not afraid to own retailers in his portfolio, owning Walmart acting for over 20 years before stepping down in 2018. However, it hasn’t been a big focus of his in recent years.

The only other retailers in Berkshire’s portfolio are the e-commerce giant Amazon and flooring and tile retailer Flooring and decor. Buffett also previously owned a home furnishings retailer RHbut out of stock at the end of 2022.

Let’s look at what might have attracted Buffett to Ulta stock.

1. Low rating

Berkshire bought shares of Ulta at a discount in the second quarter — during which time Ulta shares have fallen 33% year-to-date. Granted, it’s been up a bit since news of Berkshire’s acquisition broke, but the stock is still down about 20% year-to-date and currently trades at a forward price-to-earnings (P/E) ratio of 13.

ULTA PE Ratio data (1 year ago) by YCharts

That’s a big discount from the multiple the beauty retailer has been trading at for the past few years. Buffett and his team love a bargain, and they clearly thought Ulta stock was on the discount shelf.

Stock has been under pressure this year largely due to increased distribution, both in-store and online, from prestige brands. That prompted Ulta to lower its sales and operating margin outlook for the year. However, Berkshire’s investment team must feel that these current headwinds are manageable.

2. A resilient and growing category

The beauty category as a whole continues to grow nicely. The category has seen rapid expansion over the past three years, and growth is expected to continue, albeit at a more moderate pace. For its part, Ulta expects the category to grow in the single-digit range this year. As the largest specialty beauty retailer in the country, Ulta is benefiting from growth in this category.

At the same time, beauty has historically also been one of the most recession-proof. This phenomenon became known as the “lipstick effect”, which was first discussed by professor of economics and sociology Juliet Schor in 1998 in her book. The overspending American. Schor observed that during times of economic stress, women splurged on small luxuries such as lipstick. This theory has held up through a number of recessionary periods since, including during the Great Recession, when sales of cosmetics increased as other categories, such as clothing, saw sales decline.

During the pandemic, that spending shifted more toward moisturizers and fragrances as people wore masks, but spending remained in the beauty category. Amid recent signs of the consumer starting to lose weight, spending on perfume and lipstick both rose. According to data from Adobeonline sales of perfumes increased by more than 19% from January to May this year, while online sales of lipsticks increased by more than 37% in the same period.

3. Category leader

One of the hallmarks of Ulta’s business model is that it sells beauty products across a wide price spectrum, offering both luxury, prestige and mass-market brands in one store. This gives it one of the best assortments for shoppers while also being able to serve customers from all income demographics.

It also attracts younger customers to its stores and allows them to trade in prestige brands as they begin to earn more income, as well as for customers to mix between the mainstream and prestige categories. For example, it would not be out of the ordinary for a customer to purchase a high-end skin care product and at the same time purchase their favorite lipstick from elf Beauty. In fact, according to Circana, more than 90% of prestige beauty brand shoppers also purchase mainstream products, while 35% of mainstream shoppers will splurge and buy a prestige brand. At Ulta, they can do all of this in the same store.

4. Increase growth

Despite facing some near-term headwinds, Ulta has a number of levers it can pull to help accelerate growth. The company has one of the strongest loyalty programs in the retail space, with 95% of its sales coming from loyalty members. This gives the company an enormous amount of data to help target additional advertising and promotions to their customer base.

At the same time, while prestige distribution has grown, there is no other retailer that can offer the assortment that Ulta does across beauty categories. Ulta is also adding new and popular brands, with plans to add at least 25 new brands to its assortment this year. It also plans to expand its social media presence and increase partnerships to help drive traffic to its stores and online.

And while the company isn’t growing its store base quickly, it’s still looking to add 60 to 65 new locations this fiscal year. That’s still between 4% and 5% store count growth, which is solid.

Image source: Getty Images

Overall, it’s easy to see why Buffett and his team were drawn to Ulta. With stocks still cheap, it’s not too late for investors to buy stocks as well.