Selling Elf Beauty Shares: My Prediction for What’s Next

At the beginning of 2024, elf Beauty (ELF 0.78%) has achieved a 1,000% return over the past five years and an all-time high. Since then, it has fallen 29%. After it reported its latest quarterly earnings, investors decided to sell the stock due to disappointing revenue guidance. There was no help from the broader market, with growth stocks in a downtrend this summer.

Taking a longer view, elf Beauty has grown its sales like gangbusters over the past few years and is one of the only big brands in the beauty sector to gain spend share, stealing customers away from the old players. With shares down from all-time highs, is elf Beauty a buy or sell today? Here’s my prediction for what’s to come.

Strong revenue growth, international expansion

The first quarter of fiscal 2025 (ended June 30) showed more of the same for elf Beauty: fantastic revenue growth across the board. Total revenue rose 50% year-over-year to $324.5 million, with international markets up 91%. The brand has gained a ton of market share in North America and is now repeating the same marketing of high quality at a low price in Europe and other countries. Elf Beauty is the brand no. 4 in the UK, for reference.

Undercutting legacy competitors, elf Beauty again took share from the likes of Covergirl and Maybelline in the last quarter. It has consistently seen strong revenue growth, with sales up 316% over the past five years. This makes elf Beauty one of the fastest growing public companies in the world.

Rapid growth means high expectations for the future on Wall Street. Even though the company raised its full-year sales guidance to a range of $1.28 billion to $1.3 billion, it was below investors’ expectations. The lack of guidance expectations is a big reason why the stock is falling.

Concerns about shrinking margins

Another cause for concern with elf Beauty is declining profit margins. Operating margin fell to 12% over the past 12 months, compared to a peak of over 16%, net income actually in decline last quarter, even though sales were up 50% from 2023.

Margins are falling because elf Beauty wants to increase its marketing spend. In the first quarter of fiscal 2025, marketing accounted for 23% of revenue, compared to 16% in the same quarter last year. So what does this mean? To support revenue growth, elf Beauty is investing more and more money in advertising, which eats into its profits.

Management says it is ramping up marketing to increase elf Beauty brand awareness, which will drive further growth in long-term revenue and ultimately profits. But right now, increased marketing spending is squeezing profit margins, which Wall Street doesn’t like. This is another reason why the stock has fallen so much this summer.

ELF Data ON Report by YCharts

Is the stock cheap?

Following its retirement, elf Beauty shares now trade at a market cap of $8.77 billion. This gives the stock a price-to-earnings (P/E) ratio of 74. On a forward basis factoring in future earnings growth, analysts estimate the stock is trading at a P/E of 44 at current prices. Even taking this forward P/E at face value, elf Beauty stock looks expensive. The S&P 500 it trades at a trailing P/E of 28, for reference.

Now, some might argue that a company growing this fast deserves a premium valuation. Let’s do some math to illustrate just how big earnings growth expectations are for elf Beauty. In this fiscal year ending March 2025, management expects about $1.3 billion in revenue. In the three years after fiscal 2025, let’s say elf Beauty can double its sales to $2.6 billion. From the current operating margin of 12%, this equates to $312 million in operating earnings over three to four years.

So in four years, elf Beauty will be trading at a P/E of 28 if the market cap doesn’t change. In other words, it will take four years of above-average revenue growth for elf Beauty to trade at just the same P/E ratio as the S&P 500 today. These are extremely high expectations that elf Beauty will have a hard time exceeding (so the stock will rise).

My prediction is that — thanks to the high P/E and expectations built into the stock price — elf Beauty stock will continue to disappoint shareholders who buy today. The stock may not go much lower from here, but I think investors will be disappointed with the stock’s performance over the next five years. The price you pay for a company matters, and elf Beauty still doesn’t look cheap after its summer 2024 price drop.