Motley Fool Hidden Gems Investing - The Lipstick Effect

Episode Date: May 19, 2022

What's the Lipstick Effect? So glad you asked. (0:25) Maria Gallagher discusses: - TJX defying the recent trend of retailers struggling - How TJX can potentially smooth out its results in good economic times - Why she thinks beauty companies are the best examples of "Lipstick Effect" stocks Plus we take a call from Bryan in Kansas City and talk about how to evaluate which stocks in your portfolio might be good candidates to add to. Got a question for the show? Call our hotline: [phone] Stocks discussed: TJX, HSY, LVMUY, EL, PG, ULTA, UL Host: Chris Hill Guests: Maria Gallagher Producer: Ricky Mulvey Engineers: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

Chris Hill. Deciding which stocks in your portfolio you should add to is a common dilemma. We've got a couple of ideas to help. Motley Fool Money starts now. I'm Chris Hill. Joining me today from the financial capital of the United States of America, Maria Gallagher, thanks for being here. Maria Gallagher. Thanks for having me. The last two days on this show, we've talked about retail, and to a large extent, the way retail appears to be melting down. It's one thing for unprofitable software company stocks to get hit. It's another thing to see established large retailers like Target and Walmart get hit

the way they got hit. You and I were talking earlier today, and I think I made a comment like, yeah, it looks like all of retail is just melting down. You said, well, actually, there's TJX, which is a company we rarely talk about on this show, but is it thriving? Is it an overstatement to say that TJX is thriving right now? It's doing well. Their net sales last quarter were $11.4 billion, up 13%. Their MarMax comp store sales, so MarMax is a combination of TJ Maxx, Marshalls, and Sierra, were up 3% over 12% sales increases last year. HomeGood comps were down about 7%. So, in total, the U.S. comp store sales were flat over a 17% increase last year. So, that's really quite impressive to maintain those elevated numbers. They ended

the quarter with $4.3 billion in cash. We're seeing a lot of inventory fright and delivery pressure in a lot of these other retailers. But TJX didn't really talk about it that much. It didn't seem to be hitting them quite as hard. Their incremental fright pressure hurt their margins by about 2%. Wage pressure hurt their margins by a little less than 1%. So, that pressure, I think, was less. And Wall Street responded pretty positively to that. And I also think that TJX is classified as something called an inferior good, which I don't like the name because I think- Wait a minute. I'm sorry. That's the category for TJX? No. If you're talking about economics, you talk about the different classifications of good. So

I think TJX would be called something called an inferior good. I don't think it is, but that's the economic term, which is just a good that when that demand drops for it, when the economy's doing well and demand increases when the economy isn't doing as well. So you have things like bargain stores or places where you go when you're making more money, you probably won't go there, but when you're making less money, you will. And so I think that's also kind of a positive indicator of people are saying inflation is going to continue to be high. We're going to continue to see recessionary patterns in spending. I think TJX and some of these other kind of bargain brand places will be a place consumers will continue to go. And so I think both of those

things combined helped it be better received by Wall Street. It certainly seems like this could be a contributing factor to what we heard earlier this week from Target, because part of Target's success over the last few years has been their apparel. They've done a good job investing in their own lines of apparel, and part of the pothole that they just hit had to do with really stumbling in their apparel division. And I'm wondering if this is sort of an ongoing concern. And I don't want to just single out Target. You could pick other publicly traded apparel companies out there and say they are at risk as well. But I never really thought of TJX as being that level of competitor against Target and Gap, American Eagle, all those others. But

that's probably incorrect thinking on my part. So I think the thing that's really interesting about a store like TJX is that when people go in, they're going in to browse a lot. So they're not going in for such specific things. And so I think that that really helps them in terms of people are going in, they know that they're going to get a good deal. They know that they have lots of different options. So when you're thinking about things like inventory, shipping times, I don't think that that qualifies as much for TJX as it might for some of these other stores where you're looking for Gap-specific brand. When I go into TJX, I'll say, whatever the brand is, I just need a new pair of pants, or I just need a new shirt that kind of looks like this,

and they have lots of options. So they did see that consolidated inventories on a per-store basis is up 35%. So they do have a lot of inventory. And so I think it'll be interesting to follow the next year or two to see how that inventory, how people are responding and going into TJX and comparing to places like Target. I'm not suggesting that TJX needs to dramatically change its business plan, but this conversation is making me wonder, what can TJX do to, look, we're in something of an economic downturn right now, whether we're in a recession or not at the moment remains to be seen, or if we are in one later this year or in 2023. But at some point, we will come out of this

downturn. And if your TJX, if history is any guide, that seems to indicate you're in for a rough patch. When you look at their business, do you think there are things they can do to sort of smooth that out so that when the economy turns for the better, TJX is not looking around saying, where did all of our customers go? Yeah, I think that's a great point. I think that they work hard on creating a good brand name. I know everyone knows what Maxinistas are. I think that they create a good amount of loyalty. I think pushing that to make consumers keep them top of mind is pretty important. I think with a lot of these brands, you want to be top of mind for multiple things. So the fact that they have TJ Maxx and home goods, they want you to think of

them, whether it's shopping something for your new apartment or shopping for new outfits. And I think having all of those things kind of in one place, it's very rare that you see a TJ Maxx, not very close to a home good. So having that all top of mind for customers, I think will continue to increase that loyalty. I'm going to show my age and cultural ignorance. I did not know what a Maxxinista, is that what you said? Yeah. TJ Maxxinista, like a fashionista, agenda, but you like deals. When you and I were talking earlier today, one of the things that came up in the conversation was the lipstick effect. For those unfamiliar, this is a term that refers to when there's an economic downturn, consumers are still

going to splurge. They're still going to spend money on a little indulgence here or there. It's an economic downturn, so they're not indulging in big-ticket luxury items, but little splurge, such as nice lipstick, hence the name, but it also applies to consumer-facing companies that tend to be resilient during an economic downturn. Where do you think this applies? I mentioned this to the college student in my house this morning, and she immediately said, oh, candy. And I looked, shares of Hershey up 13% year-to-date, while the overall market is down 17%, which, among other things, means I should probably go to my kid for more stock ideas. But what do you think? I think candy is a great one. I also almost immediately went to Trader

Joe's, getting a nice little fancy snack from Trader Joe's. But I will also do some literal interpretations and talk about the beauty market. So, 71% of U.S. respondents from a recent survey are planning to spend as much or more on beauty and enhancement products in 2022 as they did before the start of the pandemic. So the beauty industry generates over $100 billion in revenue worldwide. Makeup sales were down 22% during the pandemic, but women reported spending more money on skincare. So skincare is the dominant segment of this beauty industry with about 42% of the market share. Hair care is about 22%. Makeup is about 18%. So health and beauty e-commerce sales are projected to grow at 77% between 2021 and 2026. So, I think it's a growing industry. It's

a resilient industry. It's kind of changing the way it does marketing with e-commerce. But so, you have companies like Ulta, you have Sephora, who's a part of LVMH, you have Estee Lauder, but you also have companies like Procter & Gamble, who own Secret, Olay, Gillette, Old Spice, Unilever owns Dove, Seventh Generation, and Axe. So, there are a lot of different ways to invest in the beauty market through a lot of different companies. In terms of the e-commerce piece, because this is an important piece for any retailer, how do beauty companies get over that challenge? Because I'm not buying makeup, but I imagine it's the sort of thing that you want to try it on in the store or see how it looks in a certain

that sort of thing. And I don't know, is there just a trust barrier that consumers need to get over? Because we were talking earlier about TJX. There's some impulse buying that goes on when you go there. It's hard for me to imagine impulse buying of beauty products online. So that's, I think, why skincare is so important in that factor, right? Because skincare isn't the same type of thing with, I don't know how that lipstick's going to look on me, or I don't know if that shade is right for me, but it's going to say, I love this. I love this brand. So I'm going to get their face mask or something like that. So I think beauty or skincare is a really important component of that. But a huge thing is a third of beauty product buyers interact with brands

on social media. YouTube is a top source for beauty related content. There are the watch time for makeup transformation videos on YouTube almost doubles each year. Kylie cosmetics, Kylie's brand, Kylie Jenner's brand is the most followed beauty brand on Instagram with 25 million followers. And so I think with the rise of the influencer culture, with that type of marketing, people will become loyal to a brand or loyal to an influencer who maybe has a similar skin shade to them and says, oh, well, it looks really good on them or their friends. Maybe it'll look good on me to kind of get over that barrier of trust as you end up trusting the person. And I think a lot of beauty brands have been really strategically smart in investing in marketing within influencers. And I think that's going to continue to grow. and then also you have places like sephora where you go and there are so many different brands you

can try things on and they give you gifts sometimes they give you gifts on your birthday they have all of these different things to kind of show you new brands and get you excited about new things and continue to have those as purchases i i remember a few years ago um on one of the podcasts we were talking about ulta and i want to say it was ron gross um uh but one of the people was talking about their loyalty program and whatever the number was, it was much larger than I would have imagined. So when you, you know, when you talk about sort of that type of touch point for consumers, it seems like, uh, that's just a great strategy for those types of businesses. Yeah. And they have Ulta, Sephora, a lot of these places have

so many different offerings. So you can go in and you can get your hair care and you can get your skincare and you can get your makeup. And so they have all of those things in one place, whether that's online or in store. And I think that also increases loyalty because it becomes a one-stop shop. And when something is a one-stop shop, I think you're more likely to just continue to go back instead of saying, I have to go to a different place for each of these needs. All right. Before I let you go, um, you know, this is, and it has been for months now. This has been a stock market where depending on your situation, depending on your experience level as an investor, how close you are to retirement, there are a lot of people out

there who are looking at some stocks being hit and seeing opportunities there. We got a great question at the Motley Fool Money Hotline. Dan, can you play that voicemail we got? Dan Boyd It's Brian from Kansas City. I own 20 stocks and started buying at the beginning of 2020. At the peak, I was up 75%. I'm currently 5% down. I'm sitting on some cash and I want to use it to add to my existing positions. Here's my conundrum. Should I add to the stocks that are already up at this crazy time? Increase my position on stocks that are down, but I believe in their long-term potential? Or pick some of both, the ones that I think will perform the strongest over time?

What are your thoughts? What things should I consider before deciding? Thanks. Chris Hill Thank you, producer Dan Boyd, and thank you, Brian, for a great question. Whether he meant to or not, Brian asked a question that I've been asking myself for a while now, which is, I've got some cash, I'm looking at the stocks that I own, some of them have been hit really hard. Some of them, Either they're treading water or they're up. Where should I be adding? What do you think? Obviously, we can't give personal advice for Brian. I shouldn't put it that way. Brian is the only person we can't give personal advice to anyone, so I'm not singling you out, Brian.

But how do you approach this question? Because I feel like he's asking a pretty universal question for investors who have a decent-sized portfolio in terms of the number of holdings? Yeah, it's a great question. Kind of the million-dollar question is, what's my best strategic move? So, my short answer would be option C that he gave, kind of both. But here are some things that I would think about. So, I would start by just thinking, how are you feeling right now? So, you seem, based on this, to be handling this quite rationally, really well. So I think that that shows that you're able to handle volatility well, or you're currently at the right amount of volatility for you. So I always start with thinking about your

risk tolerance and your risk. Think about things from a risk standpoint, then thinking about the individual companies. I would think through what are their long-term prospects of these businesses? What do those prospects rely on for every thesis I have for a company? I also write down, I like to write down the Achilles heel of that company. So what could go wrong for this company, for this company to go to zero. So think about their financials. Think about market sentiment. How likely are those things to happen? How likely are those things to change? And really think through that thesis. So then think through what's happened with each of these companies during their last earnings calls. What are they reporting? What are they forecasting? How long could that decline

last for if it's a decline? And then do they have a proven track record for withstanding downturns? Do they have enough cash to withstand a couple of earnings of downturns? Things like that. So I would go through this exercise for your companies and then turn that into kind of a top tier list of your favorites and highest conviction, and then see where that falls into performance. So I wouldn't start with performance and then decide for my allocation. I would start with what companies do I have the highest conviction in and then say, okay, well, how have these performed of my list of my top 10 companies? Then look at that and then kind of try and allocate based on your concentration risk, how much you want to think through your

diversification within your portfolio and diversification through sectors. But so I would start kind of thinking company-wise, thinking through risk-wise, and then go back and decide if you're going to allocate to winners and losers based on the answers to those questions. I hadn't even thought of that, but that's such a great idea to essentially remove the stock price altogether and just look instead at things like cash. And by the way, I'm sure I consume more financial media than the average person. So, just take it from me, there is so much more fear in the commentary going on. I'm not saying it's completely unwarranted, there are a lot of X factors in terms of inflation, in terms of events outside the United

States over which the Federal Reserve has no control, like can't control what is happening in Ukraine, can't control what is happening in China. But it really does seem like some of the people who are going on CNBC and Bloomberg are trying to outdo each other in terms of how much fear they want to project. But to your point, Maria, that is one of the lenses I look at in my own portfolio is the cash reserve that a company has. Also just thinking in terms of the next couple of years, hey, if the next couple of years are maybe not as bad as the last six months, but they don't dramatically improve, if the market just treads water or is slightly down, who's going to make it? That's just a binary question that I am putting all of my holdings

through. In three years, are you going to be here? In the case of a company like Apple and Microsoft, yeah, you're going to be here in three years. A couple of the stocks I own, I don't know. That's why I'm not adding shares. Yeah, absolutely. And I think for me, I also like to think about their relationships with who their customers are and how mission critical they are. So if a company, if it's providing a service to another company and the company is slashing its budget, are they still going to pay for this? Are they still going to pay for their cybersecurity offerings? Are they still going to pay for this type of advertising? how is that going to work? And where do you think those customers will be in the next three to five

years as well? So where are they going to be in terms of, can they withstand downturns? And also if there is a downturn, will their customers leave them? Maria Gallagher, always great talking to you. Thanks so much for being here. Thank you so much for having me. If like Brian in Kansas city, you want to leave a message on the Motley Fool money hotline, just call 703-254-1445. That's As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. Chris Hill, thanks for listening. We'll see you tomorrow.