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Pamper Your Portfolio With This Beauty Stock

Consider Sally Beauty Holdings over the popular Ulta

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Ulta currently trades at 47 times earnings. Its forward P/E is 31.7, based on January 2013 EPS of $2.18. Another fast-moving specialty retailer, Lululemon (NASDAQ:LULU), has a similar forward P/E ratio. But here’s the difference: Lululemon has an operating margin of 27.7%, three times Ulta’s. Either the activewear phenom is incredibly undervalued and Ulta is fairly valued, or Lululemon is fairly valued and Ulta is incredibly overvalued. My guess is the truth is somewhere in the middle, and both stocks are a little rich.

Sally, on the other hand, could be considered a GARP stock in that it’s growing at a decent clip and yet has a September 2013 forward P/E of 13.4, only slightly higher than the forward P/E for the S&P 500.

By every valuation metric, Sally is a better deal. One metric that almost every investor will ignore in this instance is the Graham Number, a quick and easy way to determine the fair value of a stock. The reason most will ignore this calculation — besides the fact it’s old-school — is that Sally has negative shareholder equity resulting from its $25 special cash dividend in 2006 to Alberto Culver shareholders. As a result of this dividend payment, Sally doesn’t show up on most stock screeners for anything related to book value.

But if you add back the $25, SBH’s current book value per share is $23.81. Multiply that by its trailing 23-month EPS of $1.14 and 22.5 (P/B and P/E guideline) and you get a fair value of $24.72 per share, 28% higher than its Nov. 28 closing price of $19.33. Doing the same thing for Ulta, we come to a fair value of $16.07 per share, 77% lower than its Nov. 28 closing price of $68.45. By Ben Graham’s standards, Ulta clearly is the mispriced stock.

Bottom Line

Ulta promotes itself as a “beauty destination” where women can go to one-stop shop for all their hair care and beauty product needs. By including an actual hair salon in its stores, it might increase the customer experience, but it definitely decreases profitability. For proof of this, look no further than Regis Corp. (NYSE:RGS), whose business model consolidating the salon business isn’t working.

If you must overpay for a stock, buy Lululemon. Otherwise, forget Ulta despite its booming earnings and invest in Sally Beauty Holdings instead. In the long term, Sally has the more sustainable business model.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned stocks.

Article printed from InvestorPlace Media,

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