Chit Chat Stocks - Why This Beauty Company Soared 600% In Less Than TWO Years (ELF Stock Report)

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Starting point is 00:01:25 The stock, which trades under the symbol ELF, closed at $26.50 in New York, valuing the company at $1.18 billion. The shares opened at $24 and rose as high as $27.40 intraday. ELF products are sold online and in roughly 19,000 retail stores in the US, according to the company. It counts Target as its oldest national retail customer, but also has agreements with Walmart stores, Gap, Old Navy Chain, and CVS Health Corp. The company also had nine of its own retail stores in the New York metro area as of August and plans to open more stores nationally in high-traffic locations. For the six months ended June 30th, ELF reported a profit of $1.1 million compared with $2.7 million a year earlier. Revenue rose 29% to 96.8 million. ELF said it aims to expand its branding to skincare and other products and that it recently introduced a skincare line priced at $4 to $12 per product.

Starting point is 00:02:35 That is a little snippet from the IPO article from the Wall Street Journal in 2016. Brett is going to be talking about e.l.f. Beauty today. I'm going to pass things to you here. I hope that gives a little bit of context for what the business was like six years ago. But suffice to say, it is in a very different position today. That is correct. And Ryan, I should say, welcome in. Thanks for everyone for joining us today. This is Chit Chat Stocks.

Starting point is 00:03:07 That was from September 2016. And a little update for you, Ryan. I think that's closer to eight years ago than six years ago. We are in the year 2024. Yeah. You know, 2016 doesn't seem, it seems like it was just yesterday. Almost a decade ago. Yeah. But we got a lot to cover today. For those of you that don't know, we are studying ELF Beauty, ticker E-L-F, stands for Eyes, Lips, Face. It was one of the hottest IPOs of 2016.

Starting point is 00:03:41 At a time when the market was really coming out of that GFC slumber, we had those tax cuts coming in and then stocks just started soaring until the pandemic hit. But if we fast forward five years after these really optimistic IPO reports, an oversubscribed IPO, stock was soaring on the day of its debut. We get to May 2022, Elf Beauty shares were actually below its IPO price, producing terrible total returns for investors while the broad market soared. During this time, the company saw stagnating revenue growth for multiple years, along with operating earnings, closures of 22 stores that were mentioned in that Wall Street Journal report, and they had the same CEO and management team with minimal strategy changes. And yet,

Starting point is 00:04:31 starting in the summer of 2022, Elf Beauty's revenue growth started to absolutely take off, as well as its stock price. As of this writing, recording, sorry, I wrote down that we're recording a podcast. We'll also have the written stuff there. Shares have enjoyed a 29% compound annual growth rate since the IPO, despite most of the time going nowhere. And since May 2022, shares of elf beauty are up 667 percent in less than two years making it one of the best performing stocks of the past few years i'll have visuals for people that don't know in our newsletter though the link will be in the show notes that you can subscribe to get all the visuals of this stuff and i think the big question is and why we i wanted to study this stock this month

Starting point is 00:05:21 is why elf beauty to me just seems like another brand out there in the the makeup cosmetics skincare space the products are incredibly cheap and you can get stuff for two three dollars and yet the the stock is just on an absolute tear so in this podcast episode we're going to do one of our stock report styles that we've started out doing here in 2024 similar to our not so deep dives i'm going to try to answer a couple of questions as ryan leads kind of through an interview a self-interview for the show here what is elf beauty why has the story rapidly changed in under two years we're gonna then we're gonna do valuation work what we can learn from the stock and then close out with whether we think the stock is a buy at these prices as always ryan

Starting point is 00:06:12 let's get started we've we've already you've alluded to the stock performance as of late i want to kind of drive this home even more since prior to the pandemic so january 2020 so this was before the business was i mean if you take it from its covid lows it looks really good but this is prior to that it is a 10 bagger within four years i think it's actually an 11 bagger so and And as you mentioned, it was the four years prior to that, it went nowhere. It was actually negative returns for four years and then the exact opposite in the last four. So we're going to go through some of that. I guess let's start with some of the history and lay the groundwork for listeners here because myself, I had no idea what Elf Beauty was.

Starting point is 00:07:01 And you're going to talk about this here, but it's mostly popular with women. So any of our male listeners might not know exactly what the brand is. Why don't you go through the business and give some history? Yeah, to disappoint the listeners out there, I guess we can't get much anecdotal evidence here. We're not going to go that far to try to drive growth on the podcast. Maybe with some other people in our lives. I did some surveys, if you want to call them that, so we can include that later on. Okay, yes.

Starting point is 00:07:29 So Elf Beauty began in 2004, and it was a classic, I would say, 21st century brand story. there was a 23 year old NYU student named Joseph Shema, a beauty entrepreneur named Scott Borba and Joey's father. They started the company. Interestingly, I thought that it was three males who would start the business. Then I was a cult following among females. And today is still led by a male CEO, which I'd kind of think wouldn't work. And, you know, are they truly going to understand the makeup market and the skincare market? And they started out basically the same as they position themselves today as a quote quality cosmetics at a cheap price originally selling products for just one dollar and like a lot of disruptors of the time it made

Starting point is 00:08:11 its name online instead of in store here's a quote from a historical piece on elf beauty quote in a unique move elf was born and sold only online making it one of if not the first digitally native beauty brands the positioning came out of necessity when glamour magazine wanted to feature one of the brand's items on its pages but couldn't unless it was nationally available for readers to buy and then after gaining notoriety elf beauty want to deal with target which has remained its largest distributor ever since and over the years it has worked to gain distribution distribution in places such as ulta beauty and walmart while also growing its online presence with its own D to C store and then Amazon shop. So what do they really sell? I mean,

Starting point is 00:08:55 it targets younger female customers, think Gen Z, millennial with cheap products that get the job done, but are still, you know, good quality and have a little bit of innovation in them. Obviously you want to try to make them fun and appealing for people to try out. So if I go to their best sellers on their website, they have a quote, you know, glow, reviver, lip oil that costs just $8. There's a, what is called a cream glide lip liner for just $2, a halo glow liquid filter for $14. I don't know what these do, but those prices are relatively cheap for stuff that you're going to use multiple times, right?

Starting point is 00:09:32 And when they compare it to the legacy brands, you know, think of L'Oreal, Maybelline, there's a lot, there's a lot out there. They're going to be significantly cheaper than what they call these prestige products. and it's not much more complicated than that. They have 24% of net sales coming from their digital sources and then the rest from physical retailers. They don't have any of their own stores anymore.

Starting point is 00:09:57 They shut those all down. And then if we go back to the history financially, in 2016, the company went public as we talked about. Revenue stagnated as we talked about. I have a lot of charts in the newsletter that people can check out here from our good friends at finchat.io. So if we look at kind of revenue from December 2017, revenue was $270 million.

Starting point is 00:10:18 And then for the fiscal year ending in March 2020, they changed their fiscal year throughout this time period, but it's still a 12-month period. The revenue was just $283 million. So it had barely budged and was probably lagging inflation. Operating income looked even worse. Operating income was $25.6 million in December 2015. and then $24 million in the fiscal year ending March 2020. So up until the pandemic, nothing changed on that front. And I think at that point, investors were fed up with Elf Beauty.

Starting point is 00:10:54 They thought, okay, this is going to be subscale forever. In February 2020, there was actually an interesting Elf Beauty short report written on Valley Investors Club at $17 a share. It outlined reasons why they would continue to struggle, including the fact that they had little success in e-commerce at the time. Only 13% of sales at the time of that writing were coming from e-commerce, and they were beholden to the targets and ultas of the world. There was the closing of the DTC retail stores. There was the fact that the CEO was a, quote, strong seller of the stock. And then the fact, which was a headwind to the entire sector, I think this is really important to why people underestimated e.l.f. is that they needed to raise prices to

Starting point is 00:11:40 combat China tariffs from 2019 that affected the entire sector. So I think the short report probably worked or the short idea worked because it was right before the March 2020 stock crash. And then there was also the headwind to the cosmetic sector as people spent less time in person in 2020 and 2021, as we all know, meaning less need to wear makeup or less need to wear it frequently um and that that hit the industry during the pandemic but as we know you know from that time period as ryan mentioned it was a 10 bagger and when the pandemic loads probably even much more so what happened i mean i think one question we're going to ask multiple times here ryan would you have any idea that this is a good buy at that time like were there any indicators

Starting point is 00:12:29 said this was a successful business? No. If you look purely at the numbers from 2016 to 2020, this would not have caught my eye in any way. I don't short, so I wouldn't have been short, but I probably would have been pretty pessimistic about this business. They rely a lot on retailers. They're beholden to them. You talked about Target being a huge customer for them. There's no pricing power. They are supposed to be the low-cost provider, but part of their low cost was going away with the China tariff. It felt like there was going to be headwinds galore. To answer your question, no. I don't think there would have been any way for me to think this is going to be an incredible investment, but something changed. Why don't we

Starting point is 00:13:25 talk about the the following couple years what changed in 2022 and what were investors missing right so in 2020 kind of the pandemic period you had three headwinds that i'll say again yeah the cosmetic industry tariffs uh you had the covet 19 induced contraction for the entire industry and then specifically for elf they had a heavy reliance on physical retailer versus e-commerce. So through March 2022, this made their growth look fairly meager. If we look at a chart here, they were growing sub 10% and profits weren't really going anywhere. And importantly, I think this made investors underrate Elf Beauty, even though they had started to gain a lot of market share in the United States. And the key is that they were getting market share,

Starting point is 00:14:21 But growth didn't look that great because the entire industry was going through a tough patch. And at the time, we saw their EV to gross profit, which I think is maybe a fine proxy for valuation, just kind of using top line numbers. It was about five, six, maybe seven. It's fairly cheap. March, May 2022, we're getting down to five, maybe even a little bit below five. And then after coming out of the kind of reopening period, which made things a little volatile for the industry, there was the, you know, like there's the reopening boom, probably, you know, a lot of people buying stuff at one time, and then they kind of went through another patch of decelerating growth. they started posting phenomenal revenue growth. And it started showing up with earnings with trailing 12-month earnings now at $144 million compared to, as we mentioned, $25 million just

Starting point is 00:15:17 a few years back. And then for the stock price, the EBITDA gross profit has gone up to $16. So there you have it. That's the 600% return. So I think what happened here is I have four things. one the cosmetics industry went from a headwind to a tailwind as the core younger consumers wanted to go out again after the pandemic second there was pent-up savings from all the consumers during the pandemic you know stimulus checks no travel huge bank balances we've seen all those charts third inflationary costs allowed elf beauty to increase prices while still retaining the gap between the legacy higher priced products and incentivizing people to trade down, I would say, and try Elf Beauty for the first time. And fourth is management, I think, put on,

Starting point is 00:16:11 and they continue to put on a masterclass in marketing, which we're going to focus on a lot today. Before we move on, Ryan, any comments there before we talk about their marketing strategy? Well, I wanted to do a double check while you were talking there. And this isn't necessarily around the tailwinds that you just mentioned but it's about the stock price itself you mentioned the incredible return since 2022 this might blow your mind elf stock since jan 1 2022 the returns have doubled in videos in the same time period nice little check there huh what what website talking about them what uh what website did you use for that oh just uh i should say finchat here but i just googled it okay but you can do that you can do

Starting point is 00:17:03 that comparison quite easily with finchat that i look at use our link to get a discount on the show notes there'll be an ad in the middle of this um that is shocking well so nvidia was kind about a little bit of a peak yeah yeah they were on their way down from they were seeing volume declines at that time at that time and then if you take it from like three months forward it's been incredible for nvidia but it's it just highlights how strong elf beauty elf beauty's performance and investors how big of a swing investor sentiment has had for elf beauty is specifically, because you mentioned it. Not only did the results improve, but huge multiple expansion here as well. Yeah. And that's, I think, a lesson broadly for people that are searching for

Starting point is 00:17:52 finding these 100-bagger type stocks. You're not going to find many of them. If you're doing that strategy, don't expect. It's not easy. We've never found any. Well, maybe. We haven't held any. And, but I think if you read the Chris Meyer book, the two takeaways are that one, you need durable revenue growth that obviously shows up in the earnings as well. And second, it is ideal to go from undervalued to overvalued, to go to see continual multiple expansion as the market starts to agree with your thesis. But let's go back to this marketing strategy because I think this is important. They've gone from, in fiscal year 2019, only spending 7% of revenue on marketing to fiscal year 2023 at 22%.

Starting point is 00:18:42 And then this year, it's going to be even higher. And they're doing that while growing their earnings. So it seems to be working. And it's the one thing here out of that list I had that is not outside of management's control, essentially. And I think it's going to be the key to their growth over the long term. And it wasn't anything too crazy. They just seemed to put their marketing dollars where the puck was going, where their core customer was, and then turn up the volume on this marketing spend to drive profitable

Starting point is 00:19:19 growth compared to, again, some of these legacy brands that toss on those cable TV ads all the time that you've probably seen. for example they have the top branded experience on roblox with four million plays they released a true crime parody documentary as an advertisement that has over two million views on youtube and that people you know think are quite funny they have tiktok focused brand collaborations that get billions of impressions and i think one of the keys is they were quite good at tiktok and you know as we saw over the last three to four years tiktok has grown a lot in popularity they have uh and usually this is a red flag but to be honest these are very good commercials um they have very

Starting point is 00:20:03 smart super bowl commercials that kind of explain quote-unquote why you should use elf beauty for example this year they had judge judy telling the court it should be a crime to overspend on makeup when elf beauty exists which i think is pretty like it's clear okay you should be using these products other people in the commercial you know the attractive people they have in the commercial the famous people are using these products and they're saying look you can get the same thing for a third of the price i think that's quite smart um and and the roi they're getting here is fantastic i should say that it has led to marketing or excuse me revenue growth accelerating to 85 last quarter do you know the brand collaborations that you mentioned on tic

Starting point is 00:20:49 tac do you think a lot of that is kind of the influencer marketing is there probably affiliate programs there that's part of it but it's also stuff like a chipotle or duncan donuts thing they just did some like a special kind of beauty kit thing that had the combined logos just as a fun knockoff thing that's supposed to go viral if you get what i mean sure all right but yes they employ the the influencer strategy yeah i would imagine because the makeup tutorials is huge across social media especially on tiktok and it seems like a perfect avenue for them that they totally succeeded at so kudos yeah yep and that's why as i mentioned they're spending a lot more as a percentage of revenue on marketing but revenue went from 100 million to gonna close in on a

Starting point is 00:21:43 billion dollars this fiscal year. And you have a lot more room given their gross margins to spend on that marketing and still earn a lot of money. You can look at any of their earnings figures. So what's interesting though, is they still have a lot of incremental dollars to invest in marketing and I think probably get good returns. They are only at an unaided awareness of 26%. I believe that's in the United States. And there's a ton of opportunity to invest internationally with only 15% of sales coming from these international regions, but growing quicker than overall sales. They just entered Italy and I think are already the number one product there, at least in a certain subsector that they care about, United Kingdom, Canada,

Starting point is 00:22:29 places like that. I think they're doing a big European push over the next few years. And then I would say over the next five to 10 years, I would expect marketing as percentage of total revenue to maybe start flatlining, maybe decline a bit, you know, but that doesn't the absolute, you know, dollars are going to, are going to grow and continue to go higher. It has now a 4.5 million, what they call beauty squad members. It's their loyalty program. They're pretty good at naming stuff. They say like, I don't know how they, they say they use like elf in all their stuff.

Starting point is 00:23:03 it's like so elfing good you know it's kind of a nice quip family friendly friendly quip there that's nice yeah not bad it's yeah it really is not bad better than the i would say you know as the counter position the legacy brands just do the same stuff with those ads on tv all the time and they have you know they're a lot of recurring spending coming from these four and a half million loyal team loyal members on their mobile application the d2c website i think it's a great asset and shows the really strong relationship they have with the under 30 customers of Elf Beauty. And I think the discussion question I have here is, hindsight's perfect. We can see why the story worked, but could you have seen this in early 2022 if you had followed the stock since

Starting point is 00:23:53 the IPO and had it on the watch list? If you were consistently following it, Yeah, I think there maybe were some indicators that they were seeing momentum. The brand adoption was there. But the problem was, if I just screen for this, if I take a glimpse at it, pretty much any point between 2016 and 2021, I'm not going to keep looking at it. I would have omitted it already. um maybe this is a good chance this is maybe where the girlfriend indicator is helpful and i say that partly in jest but when you start to see the adoption of because a lot of the investors aren't able to keep up with all the social media trends but we've seen this before

Starting point is 00:24:44 where there are brands that get really good traction with a certain cohort um and that cohort likes to spend so lululemon's a good example uh starbucks has obviously been around for quite a long time but there are certain brands i think dutch bros uh trying to think of some other ones that might be uh what's aritzia is that the one that's done really well but that's a little bit dangerous because i heard read i you read as someone that doesn't buy these products it's hard to have confidence in when the trend might be ending and that's what we'll talk about makes investing in these difficult. Before we move on, we want to talk about our friends at FinChat.io. FinChat.io is the complete stock research platform for fundamental investors

Starting point is 00:25:31 beyond having all the standard financial data for companies around the globe. They also have company-specific segments and KPIs on over 1,500 stocks. So if you want to see Amazon's AWS revenue over the last 10 years, or you want to track match groups paying users, maybe you're curious how many stores Sprouts Farmer's Market added last quarter. FinChat tracks all those KPIs and literally half a million more. We know that if you're a fundamental investor, you probably track this stuff yourself, but this saves so much time and it has all the data you already need. If you aren't sure where to go, you can also simply ask FinChat. That is their conversational AI powered by FinChat's proprietary data. So that'll save you tons and tons of time researching.

Starting point is 00:26:17 they've got stock screening tool they've got fundamental charting that is best in class in terms of design i use fin chat every day i absolutely love the platform brett does as well we both use it as our primary dashboard and the place where we do all our research so if you want to get 25 off any paid plan use our link finchat.io slash chitchat that is finchat.io slash chitchat the link will also be in our show notes. Yeah, the point is, it's almost the Peter Lynch approach, which is, it doesn't mean you go blindly into any product that's getting good adoption from your friends or significant others or stuff like that. But keep your eyes open to it. And he did this all the time with his daughters and with his family. He talks about this in his

Starting point is 00:27:05 book where anything that was popular, he'd kind of keep his eye on, he'd go to the mall, he'd check out the store and he'd really get the real world experience. And so I think Maybe there would have been the potential to recognize it that way because if I'm looking at the financials, I would have glossed over this for five years. But if you're constantly following it, it's a different story. I think you could see the momentum if you're following it every quarter, but there are very few people that were doing that. Yeah, I think the way you would build conviction and we're kind of maybe not nervous about this, but saying it wouldn't have happened to us because we don't follow the industry and we can't get much anecdotal evidence as opposed to maybe some products that more males use. If you were following the cosmetics industry, I think you would have been able to understand that there was a lot of headwinds in 2019, 2020, early 2021. one and then if you were someone that used the product or could see some of those trends on

Starting point is 00:28:04 as you mentioned social media maybe you could have gotten conviction with the stock trading at 10 to 15 times forward earnings or maybe you know some estimates there but yeah it could have been i think a good risk reward and i think it's one that you maybe position size small looking back on it because today it could have turned into a large position but let's continue Anything else, Ryan, before we – There is a fine time period there where I would have maybe taken a startup position. And you could maybe do it today too, and we'll talk about that here in a second. But if you're looking at this from 2016 to 2020, I don't think there's – I'm not walking away from it saying, well, maybe it's worth a startup position.

Starting point is 00:28:51 Once you started to see that momentum and that revenue acceleration, yeah. But that really came in what, 2021? Yeah. So their fiscal year is maybe a bit messed up. But if you look at the chart that it will have in the newsletter, remember their fiscal year's end in the March of that year. So if we go up to the chart here, yes. So fiscal year 2022, the first quarter of that, which would have been the reopening period in the summer of 2021. They saw growth of 50%. I think that was just a comeback from the pandemic for everyone. But then it wasn't until fiscal year 23, which started in spring of 2022 when revenue growth started consistently accelerating. So spring 2023, excuse me, spring, so confusing with these fiscal years, spring 2022, revenue

Starting point is 00:29:49 growth, 26%. Then by the end of that year in March, 2023, it had accelerated all the way to 78% and revenue growth has been above 75% for the last four quarters. Yeah. I mean, that's when the momentum started. Is there a period in there when he could have invested as the multiple is still fairly low? maybe. But yeah, as you said, when the market figures this out, it can be quick and you have to have that conviction from, I think, the anecdotal evidence perspective first, because

Starting point is 00:30:20 the big investment funds are going to figure that out quite quickly. All right. Let's talk about the management team because we've seen this story before where a brand catches fire and maybe it isn't necessarily durable. You really kind of got to have belief in the management team as well. So who are they? Talk about them a bit and how important do you think they are to the thesis? Yeah. So they're rung by Tarang Amin. Hopefully I'm saying that right. Amin. He joined the company 10 years ago, right before the IPO and seems to have run the same strategy for years, betting on the future of social media advertising, going after the young female cosmetic shoppers, going for the DTC website, sticking with the low price

Starting point is 00:31:03 point. From reading the transcripts, they have a strategy of having quality products with some innovation in there, trying to do unique, trendy stuff that's going to fit well on viral TikTok, Instagram videos, stuff like that. Importantly, always price them well below the prestige competition, which has the legacy cost structures and very high margins due to decades of pricing power and price increases. Use unique marketing and then repeatedly tell customers they don't need to spend a fortune on beauty products, and then also build a loyalty program. And if you look back at the stock in 2021, I think you would have said, hey, this could use an activist, right? There probably would have been a lot of calls to get rid of them in, bring in an activist investor.

Starting point is 00:31:46 But I think what attracts me to this management team is that they stuck the course with this strategy, and it finally worked. The question I have is, did they get a little bit lucky you know betting on tiktok do they get a little bit lucky uh betting on target betting on amazon betting on their dtc website maybe a little bit but i i like that they had conviction in their strategy they executed well and they didn't sway through it because they had conviction that this was the future you know even through some some tough periods there anything anything else ryan before we move on no i mean there's obviously there's some good fortune involved there there There were some tailwinds coming out of COVID, but they were positioned well to get lucky.

Starting point is 00:32:30 They had the impressive DTC website. They were the low-cost provider. They had attractive marketing. That stuff is not chance. I mean, that was well done on their part. Probably some luck with just the tailwinds, but I think you got to give Amin here, the CEO, a pat on the back for sticking with the strategy. Yeah. And after a period of bad luck. Okay. Next part on management and culture is, I'm curious your thoughts here, because I really like how they treat all the employees as owners

Starting point is 00:33:06 of the business. Here's a quote from a recent conference call. Importantly, all 300 of our employees are shareholders in Elf Beauty with a total employee ownership at nearly 15% of shares outstanding. Do you like this, Ryan? I like it quite a bit. yeah they are certainly going to be well incentivized also 300 employees that is not a lot for the size of this business i guess i don't know the market cap per se cross 10 billion right yeah well let's let's look at revenue billion so the valuation has crept up there quite a bit now but yeah revenue and just 300 employees that's pretty impressive so uh yeah if i'm gonna employee at the company, I would feel great. I'd feel motivated. I'd feel excited to work there.

Starting point is 00:33:58 So I think that's a good strategy. Yeah. And I think their efficiency is much higher compared to competitors. And it's not bad that your stock's been a 10-bagger. So people are quite probably financially set that work there. And I guess I don't know the dilution story here, but I would guess that if you're a shareholder and you're an employee, One of my big concerns typically is stock-based compensation. But if 300 employees own 15% of the shares outstanding, they maybe don't want too much share dilution would be my guess. So it maybe forces them to moderate it a bit, but I could be wrong on that. I actually haven't looked at the numbers.

Starting point is 00:34:40 Yeah, and I think for any listeners, you hear us complain about stock-based compensation quite a bit. I think the number one gripe we have with that is heavy stock-based compensation for underperformance of the executive team. Now, I think I'm all for making everyone an owner in the business, and I think that can really help drive culture. Well, let's move on to the next topic. Some things I'm concerned about with management. One, dilutive acquisitions. Previously, they've bought two companies called Keys Soul Care, which was an Alicia Keys-backed startup, and then Well People. Both seem to have done poorly. They're not talking about them at all anymore. And I think it's done quite poorly compared to the core elf brand. These were

Starting point is 00:35:23 small acquisitions looking at it now, but at the time they were fairly large. And then recently, they spent $355 million in a combination of cash and stock to acquire a company called Neturium, which is a skincare startup that's done fairly well. Time will tell if this acquisition will work, but we are already seeing in the first quarter after the close that ELF continues to accelerate and Notorium is underperforming that. Here's a quote from the conference call. We previously talked about Notorium contributing about $48 million for the year, and we expect that to be consistent. So our raised guidance really is reflective of the momentum that we continue to see behind the ELF beauty overall. So they're saying that they're beating guidance

Starting point is 00:36:07 because of Elf Beauty, but Notorium is doing just as they expected. I like this management team. I think they executed well. I think they can get revenue to efficiently grow. There's no question about that. But I have a lingering question is, which is, do they understand capital allocation and creating per share value? I would worry that they're a little bit of an empire builder of saying, hey, look, Notorium is a good asset. I'm not sure they're buying it at the right price. Is it worth to dilute shareholders from this incredible e.l.f. Beauty brand for Naturium or however you say it? I'm not so sure. In Toronto, every arrival is a statement and nothing says it better than this. Cadillac Optic was the number one selling luxury EV in Canada

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Starting point is 00:37:14 for the Cadillac definition of luxury. Yeah, I wish I could walk back my previous comments here because it seems like they might be on that side of empire building, that they are potentially conflating getting big with driving value and maybe it provides a bit of a safety valve to have multiple brands but it can certainly be a waste of capital like it could preserve them potentially if elf starts to struggle to have this naturium and what's it alicia key's brand but more often than

Starting point is 00:37:55 acquisitions are bad uses of capital in corporate America. And my guess is these would probably be similar. Yeah. And for behind the scenes for the listeners for these episodes, we do a flip-flop. So last time Ryan was the one researching and I was the one interviewing, kind of reacting as we go along. So Ryan hasn't done as a minimal research before the show and I'm the one that done the research. So it shouldn't be surprised that for anyone that, you know, some, I know others people out there they will complain sometimes if i don't know if there's any slip-ups just that's on purpose that's how we're doing these for these episodes but let's move on i think it's fun to talk about competitive advantage here especially with a consumer brand

Starting point is 00:38:37 are there any yeah that's that's the question so for first-time listeners there's three things that we could try to care about at the end of the day do we trust management is the business predictable and is the stock cheap. The second one is always a bit nuanced because we're really talking about competitive advantage analysis, sector analysis. There's a lot of variables that go into this one. I think after looking at Amin's track record and philosophy, I trust him. Maybe not perfectly. Maybe he's not on my Mount Rushmore managers, but I think solid. It's not going to keep me away from the stock. When we look at competitive advantages and predictability, i think they have fantastic counter positioning versus the legacy brands it definitely doesn't

Starting point is 00:39:21 have if we're looking at competitive advantages there's not really any switching costs there's no network effect but i do believe it has a good brand competitive position you know it can work how should i say this and they can develop economies of scale versus newcomers and startups that are not going to be able to price as cheap as they can with almost the same exact product. So if we look at brand position, I think they have a nice position in the market. The older prestige players are facing a bit of an innovator's dilemma. It's not exactly like Elf Beauty's innovating here. It's more of, okay, we can come out with the same product, but at a third of the price. Elf has come in, they've taken market share by offering quality products at a cheap price,

Starting point is 00:40:07 but these competitors aren't doing anything. The dynamic hasn't changed since 2017. And will this change over the next five years? I wouldn't bet on it. And they already are dominating with the Gen Z consumer who is going to become a heavy spender of beauty products over the next five to 10 years. Here's a quote from a recent conference call. Our strength is the number one brand amongst Gen Z with an almost 29 share of them, as well as growing other audiences. So I think they are the number one brand among Gen Z. 29 share means 29%. I think that's quite high. Ryan, any thoughts on brand before we try to move into economies of scale, the price differences, stuff like that? No, it's hard, I think, for a brand like this to really have any stereotypical or traditional competitive advantages, right? The network effect is not going to be there.

Starting point is 00:41:02 They don't have like infrastructure type advantage like an Amazon. They don't have the distribution necessarily. They might have it relative to some of the smaller peers, but they don't have a distribution advantage over a L'Oreal or something like that. When we look at it versus like a startup brand, I think social proof is really helpful here, but that's not necessarily a lasting advantage. It can really reduce your cost of revenue and the marketing associated with having to attract new customers. But I wouldn't say there's any standard, typical advantage here. That's not why you're investing. Maybe there is at some point down the line, but today it'd be hard to pinpoint any. Right.

Starting point is 00:41:51 Counterpositioning innovative's dilemma, not necessarily the standard competitive advantage, but it can be a way where you can nudge yourself into a market and really grow for a long period of time as they've been doing. And as I was saying, you mentioned, I won't read through all this because you kind of said part of that. We don't need to repeat it. When comparing two startup brands, can any other startup in the space do a Super Bowl commercial? I don't think so. And the other legacy brands seem to be asleep at the wheel from a marketing perspective. Elf seems to run circles around them. So I think that's a great position for them to be in as the only new scaled player in this space. There might be another one, but I will say I'm not an expert on this entire competitive landscape. I think the innovator's dilemma is real here. If you're L'Oreal, maybe they haven't even seen the impact yet. And to you, it's like, it's so hard to walk back pricing power once you've instituted it, especially if you're a public company and you're delivering results for shareholders. You have to answer to them every quarter. I think e.l.f. is in a much better position that way.

Starting point is 00:42:59 Yeah, and what's also interesting is I think e.l.f. Beauty has pricing power, even though they have to be a bit reactive to the Maybellines, L'Oreal's, and others. I'm just always using those as the case study example here, is they need to maintain the gap in price. But if you look at the screenshots from the website above, you can get a product like the lip oil they have. You're going to use it many times, and it's just $8. I mean, will demand fall off at all if they raise that to $10, $12? I really don't think so. And the

Starting point is 00:43:28 gap is still there, where if you look at their investor presentation, the average lip oil, whatever that is, I actually don't know what it does, but it's $40 at the prestige brand. So there's a huge gap there. If it's 12 versus 40, 8 versus 40, is that going to be a big difference for a lot of people? I don't think so. And it's not like this is a brand you show off outside this isn't a luxury brand where you go well the louis vuitton bag is 2 000 bucks but it's gonna signal that i'm whatever you know the best and there's no addictive quality to a specific taste like a coca-cola a consumer packaged good food products cigarettes blah blah blah so i think it creates more of an opening for a brand like lp to win but but conversely i think it makes the

Starting point is 00:44:16 entire sector more competitive what do you think about that it's a good point because no one's saying oh she has on elf beauty lip oil they can't tell they don't know it's more personal yeah yeah and so if you can drive the same results which there is a little bit to this right you know aesthetics is one part of it but not having bad reactions to it i know this that's a huge part of makeup like um making sure that it's actually okay for your skin and if it if it checks those two boxes right it's okay for you and it looks the same why wouldn't you pay 25 of the price yeah i think there's a reason that l'oreal is one of Now, I mentioned that the sector is a little more competitive, or I'd say opened up to more competition.

Starting point is 00:45:15 But L'Oreal, I mean, there have been dominant players in here for a long time. I think the key question to have at the end here of this section is, can Elf Beauty widen its moat over the next five years? I would answer yes, definitively, I believe it can. And I'd say all it has to do is keep doing what it's done over the last five years, and it will gain more power over the cosmetics industry, which will theoretically, you know, lead to more profit potential. However, however, I would be hesitant to say

Starting point is 00:45:44 Elf Muti has any sort of wide moat today. You know, the brand is solid, as we've talked about. People get locked in, as Ryan just mentioned, psychologically to their consumer products. But there's nothing about this business that screams wide moat. You know, there's not, the brand is not like a luxury brand or a, you know, like we mentioned,

Starting point is 00:46:02 a Coca-Cola type consumer product. there's no high switching cost software here there's no economies of scale retailers like or you know like at a retailer like costco or amazon i don't this doesn't make it a bad business but i think it will inform my opinion and i i believe should inform any investor's opinion on what earnings multiple i believe the stock deserves to trade it there are some it's not necessarily like a switching cost but once the habit is formed with a certain brand it feels pretty rare that people switch because if it's working you know if if you feel good with product on there's not really that much incentive to change and you kind of just buy it on a

Starting point is 00:46:50 recurring basis when you need it it seems like so i would say they're the ones undercutting price So no one's going to undercut them. Having that value with Gen Z, I would not be surprised if those customers stick around for a long, long time. And unless they just price gouge, which seems unlikely, I imagine they'll be able to retain those customers. Yep. And they have what they – I love what they call the loyalty program, the beauty squad at four and a half million members. And I think it's grown 30% year over year. let's talk numbers what do you think about the valuation today yeah so listeners will know that

Starting point is 00:47:31 we keep things complicated with management and competitive advantages we'll talk about that for maybe 10 minutes but we keep it real simple and valuation to kind of answer that third question we go through and i think with elf it's going to be two factors what are operating margins going to be what is revenue growth going to be revenue growth is probably the most important over the next few years. I ran a few projections with varying revenue growth and margin assumptions going out to fiscal year 2026, which is just two years of projections. So if you want to try to get funky, go out 2028, 2030, be my guest. Today, Elf Beauty is growing revenue 85% year over year with just above 15% operating margins. And I think continued growth at a lower rate and margin

Starting point is 00:48:18 expansion is reasonable, especially with international push, where they've seen quite strong success there. I mean, TikTok, Instagram are global presences, and that's where their marketing function is. So they can push it into a lot of other markets. And with the cheaper price points, they can go into places like Latin America and not have much problem. Here's a quote from them on their international presence as well. We're super excited about what we're going to be able to do in Italy and the response of the brand there. You will hear about additional countries in the coming quarters. I don't think you'll ever hear us talk about going to 30 countries all at once. So it's going to be meticulous, but there's a huge potential for

Starting point is 00:48:55 growth there. And it kind of took a number out of a hat here and assumed 40% revenue growth under an optimistic scenario because 85% growth is not going to continue forever. And then under another optimistic scenario, I assumed 25% operating margins. And the way I did that is I kind of projected what operating income could be in fiscal year 2026 and then looked at the market cap today and said what the price to operating income would be. So if we go through it, under 40% revenue growth, 25% operating margins, the price to operating income would come down to 21 in the fiscal year 2026 and would trade at 41

Starting point is 00:49:39 this year. Again, they're not going to do that margin this year. It's theoretical. cycle. And then if we assume revenue growth, I'm trying to be a little bit pessimistic. I know people love the stock, but you have to kind of go through some downside stuff. And I don't think 20% revenue growth is that unlikely. We go down to 20% revenue growth for two years, and then operating margin stays at 15% because they have to spend a lot of marketing, stuff like that you'd be trading at 47 times operating earnings in 2026 and the question is would elf

Starting point is 00:50:14 be trading at 47 times operating earnings in 2026 under this scenario i don't think so i think it would be down quite a bit um and yeah that that's that's all my valuation work it's it's nothing special? I mean, if it slows to 20% revenue growth, obviously, and the margins stay similar, I think you're going to see some multiple compression, maybe some investors that kind of leave. Here's my issue, and I go through this all the time. I see a business like this where there is clear growth, huge ceiling, huge upside, and I sit there and look at the headline numbers, I look at the headline valuation, I say, well, if things go wrong, I'm kind of screwed. Well, here's the thing.

Starting point is 00:51:12 Would you buy shares today? Yeah. And the answer is no, because I believe there's minimal upside for shareholders over the next few years, and a lot of potential downside. Because even under an optimistic scenario, what are you going to trade at a market multiple? You got to expect the stock to be trading at 40 times earnings. I mean, you can go through varying scenarios with the growth and margins there, model out what you're expecting at this price. Is this price at a $10 billion market cap expecting two more years of 50% growth, 60% growth, and margin expansion? I think that is a tall ask, and you still might underperform if that happens.

Starting point is 00:51:51 I think the downside is quite high if the multiple contracts. We could see the multiple contract back to a market multiple, and you could be down 50%, 60%, 70% within a few years if revenue decelerates. For this company, especially because I don't think it is a wide moat business today, and it's not a sector I know that well, I would buy shares if I was confident in durable growth and maybe an earnings ratio of 10 to 15, which is very far from here. And I think it's, I would call this an incredibly risky stock at these prices to buy. I'm not saying it's guaranteed to do poorly, but buying today, I think is a terrible risk reward. If you're a long-term shareholder and it's been a 10-bagger for you, I don't think there's any reason to sell because, hey, you don't want to take the tax hit.

Starting point is 00:52:37 they've done things so well okay there might be a 50 percent drawdown but it's still an incredible performer for you but is it wise for someone to buy shares trading at the snow to be nosebleed multiple after such miraculous revenue growth i don't think so i was gonna say what are the odds this is the next celsius because it's kind of similar in some ways but already was it already is the next Celsius, I guess, because it's already similar valuations. Actually, quite similar numbers, if I'm not mistaken, as well.

Starting point is 00:53:13 Similar market cap. There is a scenario where they're doing $10 billion in revenue in 10 years. Yeah. But there's obviously risk.

Starting point is 00:53:30 There's a lot of risk that that doesn't happen. And so So my takeaway from your report here is that it's okay to have this. If you've owned this for a while, congratulations. I wouldn't sell it either. And the longer I've been investing, the more I've learned to just never sell my winners. I'm officially in that camp, I think. But if you're going to buy today, I would say do it pretty small.

Starting point is 00:53:59 A starter position Would be the end of the world here Yeah, it's going on the watch list We'll see It's a decent brand, they seem to be quite smart Alright, that's going to sum it up Let's hit the disclosures If you enjoyed this episode, if you got to where we are now

Starting point is 00:54:14 I would recommend to follow the show on YouTube Spotify, Apple Podcasts Wherever you listen to these type of shows Follow us on our newsletter to get updates on the show Give us a 5 star review On Spotify or Apple Podcasts It is the best way to help this free content and make it stay free for a long, long time. As a disclosure, we are not financial

Starting point is 00:54:34 advisors. Anything we say on the show is not formal advice or recommendation. Ryan, I, or any podcast guests may hold securities discussed in this podcast, may have held them in the past, and may buy, sell, or hold them in the future. Thank you, everyone. We'll see you next time. Thank you.

Chit Chat Stocks - Why This Beauty Company Soared 600% In Less Than TWO Years (ELF Stock Report)

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