This Investment Firm Just Boosted Its Shares of Ulta Beauty. But Does It Make Sense as a Long-Term Buy and Hold?

A buy-and-hold strategy might just be the key to outperforming professional investors.

If you bought shares of cosmetics retailer Ulta Beauty (ULTA 0.09%) 10 years ago, you should be quite satisfied. After all, the beauty stock is up more than 300% in the past decade, far outpacing the return of the S&P 500.

However, the performance of Ulta Beauty stock year to date is another matter entirely. Shares have dropped more than 20% compared to a stellar 16% gain for the S&P 500, as the chart below shows.

ULTA Chart

Data by YCharts.

Where some investors might be driven to despair, others smell an opportunity. For example, various hedge funds have increased their positions in Ulta Beauty this year, including SteelPeak Wealth.

This isn’t necessarily breaking news — SteelPeak Wealth updated its holdings with the SEC back in April. And this hedge fund owns hundreds of stocks, so its $1.5 million investment in Ulta Beauty is a relatively small holding in its portfolio.

Caveats aside, SteelPeak boosted its position in Ulta Beauty by 25% in the first quarter. And it’s possible that it continued adding to the position in the second quarter — investors won’t know for sure until it files an updated report. But remember, hedge funds are run by investing professionals. What would a professional see in a company like Ulta Beauty?

There are a lot of things to like about the business, but it may be retail investors who can better take advantage of the opportunity.

Here are some things to like about Ulta Beauty

Ulta Beauty gets 95% of its revenue from its 43 million loyalty members. That’s been the case for several years now. But over time, active members in the loyalty program have increased, and average spending per user has also increased. Since this has been true for a long time, it’s reasonable to expect relatively steady sales for Ulta Beauty, thanks to its most loyal customers.

Turning to profits, Ulta Beauty had an operating margin of 14.7% in its fiscal 2024 first quarter (ended May 4), and management expects a 13.7% to 14.0% margin for the full year. Admittedly, that’s down modestly from its peak a couple of years ago, but profitability is still good, leaving this debt-free company with even more cash at the end of the day.

Finally, the stock’s valuation is attractive. Its price-to-earnings (P/E) ratio is about 15, roughly 50% lower than its 10-year average. It’s also significantly lower than the average valuation for the S&P 500.

ULTA PE Ratio Chart

Data by YCharts.

Put it all together, and hedge funds like SteelPeak are probably buying Ulta Beauty stock because they see a company with predictable income, above-average profits, and a cheap stock price.

Why ordinary investors have an edge

So, is Ulta Beauty stock about to bounce back and race to new highs?

Not so fast. Shares of good companies can be undervalued for a long time, just as shares of bad companies can be overvalued for a long time. Eventually, however, stock prices will come to reflect a business’s fundamentals, but time is precisely the one thing that most pros don’t have.

Many hedge fund professionals are under pressure to deliver fast results for their investors. After just a few quarters of underperformance, investors might move their funds elsewhere. In contrast, amateur investors invest their own money and consequently only answer to themselves. They can choose to patiently buy and hold if they like.

Patience is a powerful ally. Looking back at Ulta Beauty, for example, the stock comes with risks just like any other investment. But even assuming the company fails to grow and only maintains its current level of business, it can earn over $1 billion in annual operating profits.

Ulta Beauty is debt-free, so it doesn’t owe that $1 billion to anyone. It can simply invest it back into its business, return it to shareholders, or a combination of both. Again, positive returns aren’t guaranteed — nothing in the stock market is. But given enough time, it’s hard to see how a business that’s consistently profitable won’t deliver solid returns for its shareholders.

This ability to be patient gives ordinary investors one of their best advantages over professionals. And this is how they can outperform the pros, even when investing with them in Ulta Beauty stock.

Jon Quast has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Ulta Beauty. The Motley Fool has a disclosure policy.

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