In the second quarter of 2024, the 'Oracle of Omaha' Warren Buffett rarely took a position in a beauty stock - $Ulta Beauty(ULTA.US)$ 。

According to the Form 13F report, Buffett's Berkshire purchased 690,000 shares of Ulta stock in Q2, with a Market Cap of 0.266 billion dollars.

Ulta is a major growth stock in the U.S., but its stock price has retraced 45% from its peak this year, making it one of the poorest performing constituents of the S&P 500 Index.

Why has ULTA fallen so much this year? What exactly does Buffett see in this beauty stock? What are the future prospects? This article will help answer these questions.

Why has ULTA fallen so much this year?

Ulta Beauty is an American beauty retail chain that went public in 2007 and is currently one of the largest beauty retail brands in the U.S., with nearly 1,400 physical stores across the country.

Unlike traditional beauty retail stores, Ulta not only sells high-end brands but also mass-market products, catering to both 'high and low-end' markets. Moreover, it offers various salon services in-store, providing a unique experience for beauty consumers.

Additionally, what ULTA takes pride in is its strong membership cash back program (Ulta Beauty Rewards), which simply translates to points for cash back, significantly enhancing member loyalty, with a total of 43 million memberships by the end of 2023.

These two factors have contributed to Ulta's rapid growth, with sales revenue soaring from $0.755 billion in fiscal year 2007 to approximately $10.209 billion in fiscal year 2023.

Ulta's stock price also rose, climbing from over $30 at its initial public offering to a peak of $574.76, truly making it a high-flying stock.

However, maintaining the leading position in the industry is not easy. As 2024 approaches, Ulta faces considerable pressure, causing its stock price to drop from the year's high of $574.76 to a low of $318.17, primarily due to the following two reasons:

First is the intensified competition: the cosmetics retail market has relatively low entry barriers, and Ulta has many competitors, with its biggest rival being Sephora, a subsidiary of LV. Ulta's stock price has been under pressure this year, partly due to a new competitive dynamic with Sephora, which has opened about 1,000 'shop-in-shop' concept stores in Kohl's department stores, putting pressure on Ulta Beauty's market share.

Second is the slowdown in the beauty market growth: In April this year, Ulta released its Earnings Reports, and the company's management indicated that they observed a slowdown in the growth of the global cosmetics and Luxury Goods markets, lowering Ulta's annual revenue growth forecast to 3-4%, and projecting fiscal year 2025 revenue to be $11.5 billion, which is more pessimistic than the market's expected growth of 5%.

What are Buffett's reasons for buying ULTA?

Buffett's investment strategy typically leans towards companies with competitive advantages, strong management teams, and reasonable valuations.

According to research by Wall Street Analysts, Buffett's reasons for buying Ulta may be the following four points:

1. Relatively cheap valuation

First of all, after a wave of decline this year, Ulta's stock price is relatively low in valuation.

The PE ratio is a commonly used indicator to measure whether valuation is high or low. Investors can check the corresponding PE ratio based on stock price changes on the individual stock page of Futubull by clicking on the 'PE' indicator.

It can be seen that when Ulta fell to this year's low of $318, the PE ratio at that time was only 12.31 times, while the average PE ratio of Ulta in the past three years was 20.59 times, indicating that the PE valuation was much lower than the historical average of the past three years.

2. Shareholder return

Secondly, Ulta has begun to focus on shareholder returns. The company announced a $2 billion stock buyback plan in March of this year, with $1.8 billion remaining as of early May.

Ulta is able to provide stable shareholder returns because the company has consistent free cash flow. Over the past five years, Ulta had free cash flow of over $0.8 billion in four of those years.

3. A large membership base

Cosmetic retail is an industry with relatively low entry barriers, therefore Ulta's competitive advantage lies in having a large membership base, with the proportion of consumer spending continually on the rise. The number of memberships increased from 6 million in 2007 to 44.2 million last year, and the membership spending ratio rose from nearly 50% to over 95%.

4. Defense in the face of economic weakness

Since the beginning of this year, the market has been concerned that economic weakness may lead to decreased consumer spending, resulting in poor stock performance for many consumer goods companies, such as Nike and Lululemon.

However, the beauty and cosmetics category is relatively unique; during an economic downturn, it may be more resilient mainly due to the "Lipstick Effect." The "Lipstick Effect" refers to the phenomenon where consumers may cut back on large purchases during a recession, but the demand for small luxury goods is expected to increase. Therefore, the economic downturn pressure has limited impact on Ulta, which has a full price product line ranging from affordable to high-end.

What should we look at next?

It is worth noting that this time, Buffett's stake in Ulta only accounts for 0.1% of his entire portfolio, which can be considered insignificant. Therefore, this data alone may not clearly reveal Buffett's strategy, and attention should be paid to whether Buffett will continue to increase his shareholding in Ulta.

Additionally, investors can pay attention to whether Ulta's fundamentals will improve; if subsequent revenue growth resumes and the earnings report data exceeds expectations, it may drive the stock price.

Technically speaking, on Ulta's daily candlestick chart, an M-shaped chart pattern has emerged. The appearance of this pattern generally indicates a potential downtrend, and Ulta's stock price has at one point fallen below the neckline.

However, after the news of Buffett's stake being established was announced, the stock price began to rebound. The neck line at $375 may serve as a potential resistance level, and in the short term, investors can pay attention to whether Ulta's stock price can break through and stabilize at this position.

Risk Disclosure: This content does not constitute a research report, is for reference only, and should not be used as the basis for any investment decision. The information contained herein is not a comprehensive description of the securities, markets, or developments mentioned. Although the sources of information are considered reliable, the accuracy or completeness of the above content is not guaranteed. Furthermore, there is no guarantee regarding the accuracy of any statements, viewpoints, or forecasts provided in this article.