By Jacob Sonenshine

Beauty is in the eye of the beholder -- and investors don't like what they see from beauty stocks. That's created an opportunity for investors to scoop up e.l.f. Beauty on the dip.

Shares of e.l.f. -- known for its cheap "dupes" of higher-end makeup -- have dropped 39% from record highs in early 2024, despite beating earnings estimates in the second quarter for the seventh time in eight quarters. It's not the only one that is suffering. Coty, the parent company of Kylie Cosmetics, Sally Hansen, and others, has been cut by more than half since its 2024 peak, while Estée Lauder is down 42% from an early 2024 multi-month peak. Concerns include slowing growth, fickle consumer tastes, rising costs, and shrinking margins.

E.l.f., however, stands out from its competitors. It's reaching its cohort of customers the right way -- by marketing on social media, selling online, and selling in select retail locations -- enabling it to take market share and grow faster than the industry. The fact that it's still relatively small should help it grow faster than its larger peers, particularly as it expands globally. Its position as a steep discounter in the beauty business gives it wiggle room to increase prices to protect its profit margins from tariff costs and still be a discounter.

"We rate ELF Buy as we believe it is a structural growth story driven by innovation, captivating marketing...as well as the international and skincare growth opportunities," writes TD Cowen analyst Oliver Chen.

The beauty-product business, after a pandemic boom, is maturing. In the developed world, most folks have already become habitual purchasers of makeup and cosmetics. Cognitive Market Research forecasts global beauty spending will grow at just over 4% annually through 2031 to over $370 billion, with the gains coming from gradual population growth and mild price increases, less than half of what it was in 2021.

That slowdown has limited growth expectations across the industry. Beauty-product retailer Ulta Beauty saw sales grow 16% annually from the end of 2020 through 2024, but now analysts forecast just 6% growth this year, according to FactSet, and 5% annually through 2029.

E.l.f has separated itself from its competitors. The $7.3 billion company produced $354 million of fiscal-first-quarter sales for the period ended in June, for 9% year-over-year growth, about double the industry's growth rate. Growth in the U.S. was 5% in the first quarter, while international sales, which still account for less than a fifth of total revenue, grew 30%, driven by entry into new countries. In the United Kingdom, e.l.f.'s sales grew at three times the rate of its competition.

Management, which usually provides conservative revenue guidance and then beats analysts' sales estimates, was confident enough to forecast a second-quarter rate "above the 9% net sales growth that we delivered in Q1," said Chief Financial Officer Mandy Fields on the earnings call on Aug. 6.

After the call, Deutsche Bank analyst Stephen Powers concluded that growth could hit 20% or more during the second quarter as e.l.f. gets a boost from its acquisition of Rhode, which closed in early August. Sales at Rhode -- model Hailey Bieber's skin-care brand -- are running at over $50 million per quarter, according to the acquisition announcement. Without that additional revenue, e.l.f.'s growth would be slower but still in the double digits.

E.l.f. is taking market share, something it has done for 26 consecutive quarters, and that should continue in the months ahead thanks to the company's efforts to get its products in front of shoppers at new locations. On the company's earnings call, CEO Tarang Amin said its partnership with Dollar General has paid off, with the majority of sales there coming from first-time customers, many in rural areas. It also sells on its own website, but to get customers to shop -- online or in store -- e.l.f. has aggressively advertised on TikTok, where it reaches young shoppers. The company spent just over $78 million on marketing and digital investments in the second quarter, up about 5% year over year.

The only wrinkle is the profitability picture. E.l.f.'s gross margin dropped to 69.1% in the fiscal first quarter, from 70.8% in the same period last year, as tariffs increased costs for the materials that make up the products, which the company imports from China. That's not likely to improve immediately -- management expects more tariff impact during its second quarter, reflected in guidance for margins based on earnings before interest, tax, depreciation, and amortization, or Ebitda, of 20%, suggesting a decline of 3.8 percentage points from 23.8%. The company also plans to move some of its marketing spend from the first quarter to the second.

E.l.f. is passing some of the higher costs along to consumers. In May, it announced a $1 increase on some of its products, which was implemented on Aug. 1. E.l.f. didn't speak of any resulting decline to demand from the increases -- the company said its products would remain cheaper than the competition, with three quarters of its offerings below $10 -- and TD Cowen's Chen writes that sales growth for the second to last week of August, the last of his most recent data, accelerated to 10% from high single digits in the prior couple of weeks.

"We're optimistic [the impact] will be limited from the recent $1 price hike, which, along with strong unit momentum, should boost sales," writes Jefferies analyst Ashley Helgans, who has a Buy rating.

It should be clear sailing for e.l.f. once the tariff impact is past. Analysts expect gross margins to rise to 71% by 2027, while sales should grow by 18% annually to $2.17 billion by the end of that calendar year. Combined, e.l.f.'s earnings per share should grow by 22% a year, to $5.12.

The stock isn't exactly cheap at 35 times 12-month forward earnings, but it's below its peak of 62 times over the past five years and its five-year average of 39. The current multiple is also only 10.7 points above the 24.3 times for the small-cap Russell 2000 index, down from the average premium of 19 points in the past three years. If earnings grow as expected and the multiple remains where it is, the stock could hit $165 by the end of 2026, a 27% gain from Wednesday's close of $130.16. A higher multiple would spark even larger gains.

And that would be a beautiful return.

The Technical View

The stock is among a strong group of vanity plays, including Ulta Beauty and Sally Beauty. It has demonstrated excellent action since a poor earnings reaction on Aug. 7 that bounced off the very round 100 number. It is now comfortably above a $124 price point and its weekly time frame is attractive as well, showing a bullish inverse head-and-shoulders formation. The price could hit $150 by year end. Remain bullish as long as the stock trades above $119. -- Doug Busch

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com.

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

September 04, 2025 01:30 ET (05:30 GMT)

Copyright (c) 2025 Dow Jones & Company, Inc.