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Chuck Carnevale
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Peter Lynch Taught Me to Invest in Ulta Beauty

Due to the power of compounding, a fast-growing business will generate significantly higher future earnings than a
slow-growing business

February 02, 2018 | About: ULTA +0% PRNA +0% CMG +0% SRCL +0%
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Introduction The Retail Sector 19

PCG - A Utility in Distress 4

In his best-selling book “One up on Wall Street,” Peter Lynch included this subtitle on the
PYPL - Watching Closely 3
cover: “How to use what you already know to make money in the stock market.” Later in the
Quality of management 6
book he talks about “the power of common knowledge.” Stating it over simplistically, Lynch
often talked about getting his best ideas from observing his family’s shopping habits. SolarEdge 1

The Secret to Success to Investing in the Stock Market 3

Last weekend, I had a Lynch “invest in what you know” experience of my own. My daughter
Valeant 10
came to visit, and she and my wife went out shopping. When they returned, they had a large
Designing the life of a Value Investor 3
bag full of makeup and cosmetics from Ulta Beauty Inc. (NASDAQ:ULTA). So, of course, in
François Rochon: "The Art of Investing: Analyzing Numbers
the spirit of my respect for Lynch’s wisdom, I immediately turned to FAST Graphs and brought and Going Beyond" 3
up an earnings and price correlated graph on the company.
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2/13/2018 Peter Lynch Taught Me to Invest in Ulta Beauty - GuruFocus.com

Performances of the stocks mentioned by →

Chuck Carnevale

Current Gain
Symbol Company Change (%) P/E ROI
Price (%)

PAG Penske Automotive Group Inc $ 48.07 -1.11 (-2.26%) -0.8% 6.73 8.8
Summary -2.26% -0.8% 6.73

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samahajoe High Drop

What I found was a very pleasant surprise. Ulta Beauty has a fabulous history of consistent ow41 2-12-18 Growth
historical earnings growth averaging 35% per annum since 2009. But best of all, this hafizrd Watchlist
consistent growth stock appears to be trading at a low valuation relative to its high historical ttaranto Over 10% EPSG, XX% off HI PE,
growth. On the other hand, the company appears fully valued based on future expectations for
ULTA Price Chart →
growth. Nevertheless, the company also generates consistent and strong operating and free
cash flow growth, and has a pristine balance sheet with only 0% debt to capital.
1D 5D 3M YTD 1Y 5Y 10Y All

$206.79 (1y: -24%)

Personally, I have a great deal of respect
ULTA 30-Year Financial Data
and admiration for Lynch and his teachings. 300
The intrinsic value of ULTA
However, I also have too much respect for 200

Peter Lynch Chart of ULTA him to simply purchase Ulta Beauty solely
100
because my wife and daughter like to shop Apr '17 Jul '17 Oct '17 Jan '18
there. You see, while it’s true Lynch often got ideas from observing his family’s shopping
habits, he also believed in conducting comprehensive fundamental research and due
diligence.

MarketWatch published an article on Dec. 28, 2015 titled: “Peter Lynch, 25 years later. It’s not
just 'invest in what you know.'” The following excerpt validates and elaborates on Lynch’s
philosophy:

Peter Lynch wants you to know that his ideas are being misquoted widely.

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2/13/2018 Peter Lynch Taught Me to Invest in Ulta Beauty - GuruFocus.com

"I’ve never said, ‘If you go to a mall, see a Starbucks and say it’s good coffee, you
should call Fidelity brokerage and buy the stock,’'"Lynch says, some 25 years after his
retirement from running Magellan Fund was front-page news.

Following the market still at age 71, he instead explains his philosophy this way:

Use your specialized knowledge to hone in on stocks you can analyze, study them and
then decide if they’re worth owning. The best way to invest is to look at companies
competing in the field where you work. Someone with deep restaurant-industry
experience would have predicted the success of Panera Bread Co. (PNRA) and
Chipotle Mexican Grill Inc. (NYSE:CMG), he says: "If you’re in the steel industry and it
ever turns around, you’ll see it before I do."

What’s wrong with the popular-wisdom version of his ideology, which is usually cited as
'invest in what you know'? It leaves out the role of serious fundamental stock research. Guru News →
"People buy a stock and they know nothing about it," he says. "That’s gambling and it’s
not good." Carl Icahn's Joint Statement With Darwin Deason Regarding
Xerox by Holly LaFon
Century Management: Market Appears to Be in a Correction,
Not a Bear Market by Holly LaFon

In summary, just like Lynch, I have often gotten my best growth stock ideas from observing First Pacific Advisors' Top 5 Buys of the 4th Quarter by Holly
LaFon
what family and friends are buying and what they like. On the other hand, just like Lynch, I
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believe in conducting comprehensive fundamental research and due diligence before I invest.
This is important because often what is popular with the public is also simultaneously what is
overpriced by the market. Value Ideas →

Note, my series of articles for 2018 will be written to present what appear to be attractively AlphaOne Investment Services, LLC Buys International
Business Machines Corp, SPDR S&P Retail, SINA Corp,
valued research candidates that also reflect a timeless value investing principle. Therefore, Sells Micron Technology Inc, Facebook Inc, Bank of America
Corporation by insider
my secondary objective for the year will be to provide pre-screened and apparently attractively
Petersen Flynn & Dinsmore Inc Buys Reliance Steel &
valued research candidates available for different investment objectives. I decided to do this Aluminum Co, Ishares MSCI India, Gilead Sciences Inc,
because one of the biggest complaints I am hearing from investors today is it is hard to find Sells General Electric Co, The Mosaic Co, Qualcomm Inc by
insider
attractively valued investments in this overheated market. Keep in mind that in every market - LVW Advisors, LLC Buys iShares Core U.S. Aggregate
whether it is a bull market or a bear market - there will be attractively valued stocks to be Bond, Vanguard Growth, PIMCO Enhanced Short Maturity
Active Exchange-Trad, Sells Energy Transfer Equity LP,
found. To learn more about my plans for 2018, check out my introductory article here. Targa Resources Corp, Enterprise Products Partners LP by
insider

Ulta Beauty at a glance Dumac, Inc. Buys Redfin Corp, Carrizo Oil & Gas Inc,
Resolute Energy Corp, Sells JBG SMITH Properties, Altaba
Inc, Alere Inc by insider
Zacks published a research report on Jan. 30 that nicely summarizes Ulta Beauty’s current
operating results. The report was titled “Can Ulta Beauty’s Robust Strategies Offset Hurdles?"
More By Chuck Carnevale →

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2/13/2018 Peter Lynch Taught Me to Invest in Ulta Beauty - GuruFocus.com
Mr. Valuation Plans for 2018: A New Year, a New and Better
Approach - Jan 18, 2018

“Ulta Beauty Inc. has been gaining from its effective marketing initiatives, loyalty Are These Dow Stocks as Cheap as They Appear? Part 5 -
Oct 25, 2017
program, sturdy e-commerce business, superb salon operations and strength in
Why Are These 6 Dow Stocks Fairly Valued? - Oct 19, 2017
prestige cosmetics. Additionally, favorable traffic is driving comparable store sales
The 6 Most Expensive Stocks in the Dow Jones Industrial
(comps) growth. The company’s notable growth in e-commerce sales has also helped it Average: Part 1 - Oct 06, 2017

stand out amid intense online competition. However, declining margins and stiff
competition remain impediments. The company shares have declined 13.6% in the past
Guru Interviews →
three months, underperforming the industry’s growth of 19.8%.”
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About Ulta Beauty, from its website:
A Conversation With Charlie Munger and Michigan Ross in
2017 by Grahamites
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"Ulta Beauty (NASDAQ:ULTA) is the largest beauty retailer in the United States and the
premier beauty destination for cosmetics, fragrance, skin care products, hair care
Top Ranked Articles →
products and salon services. Since opening its first store in 1990, Ulta Beauty has
grown to become the top national retailer providing All Things Beauty. First Principle Thinking - How Great Minds Think by
Grahamites

The Company offers more than 20,000 products from approximately 500 well- How to Find Great Businesses – Without Resorting to Actual
Math by Geoff Gannon
established and emerging beauty brands across all categories and price points,
The Evolution of My Research Process - Part II by Grahamites
including Ulta Beauty’s own private label. Ulta Beauty also offers a full-service salon in
What Can We Do Now? Part II by Grahamites
every store featuring hair, skin and brow services.

Ulta Beauty is recognized for its commitment to personalized service, fun and inviting
stores and its industry-leading Ultamate Rewards loyalty program. As of October 28, You May Also Like →
2017, Ulta Beauty operates 1,058 retail stores across 48 states and the District of
Columbia and also distributes its products through its website, which includes a Ulta Salon's Expansion Moves Can Turn Out to Be Long-
Term Catalysts
collection of tips, tutorials and social content.”
Ulta Salon Has Many Reasons to Believe In Its Beauty
Ulta's Performance Continues to Improve as Executives Buy
Back Shares
A Promising Pick for the Future
Value investing principle: Higher growth is worth a higher valuation
Ulta Salon Is Not A Good Buy At Current Levels
In part one of this series, I discussed how even companies with no growth had value worth
more than one times their income stream. I also pointed out that 15 times earnings as a norm
was more or less a reasonable valuation derived from a baseline multiple of a non-growth,
fixed-income interest rate. This also relates to investing only when the company’s earnings
yield is equal to or greater than typical yields available from quality fixed-income instruments
(15 price-earnings ratio equals 6.67% earnings yield).

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It should also be noted that when growth was 5% or lower, dividends became more prevalent
and important. From 5% growth to 15% earnings growth, dividends continued to play an
important role. For these mid- to approaching high-growth ranges, the current dividend yield is
typically less, but grows faster. Of course, these are generalizations that apply prominently,
but not in all cases.

Today we move to the third category of pure growth of 15% or better. When earnings growth
rates are at, above or near 15%, you will often find characteristics that are similar to the 5% to
15% category. As rates get higher, however, dividends become rarer and price-earnings ratios
increase to reflect the higher growth. Much of this can be attributed to the reality that a fast-
growing company needs to utilize all or most of its available capital to fund growth.

At these higher growth rates, the concept of the PEG ratio (price-earnings to growth) comes
into play. The PEG ratio is a reliable indicator of intrinsic value for fast-growing businesses up
to a point. There are no hard-and-fast rules here. Instead, common sense principles are
based on mathematical realities. Coincidentally, Lynch is also widely considered the originator
of the price-earnings ratio equal to the company’s growth rate as a valuation indicator. Lynch’s
ideas have morphed into what is commonly called the PEG ratio.

Due to the power of compounding, a fast-growing business will generate a significantly higher
level of future earnings than a slow-growing business. Consequently, with companies that are
growing very fast (15% or better), you end up paying a much lower future valuation for the
significantly higher level of future earnings. However, it is implicit that those higher forecast
earnings levels actually become real. Nevertheless, because a fast-growing company
generates such a high level of future earnings, its implied current intrinsic value level will
naturally be higher than a slow-growing business. On the other hand, it’s very difficult for a
business to grow fast. Therefore, higher-growth stocks also carry greater risk. Note, at the end
of the video in this article, I will illustrate just how risky growth stocks truly are with a look at
Stericycle (NASDAQ:SRCL).

Furthermore, when I am trying to determine the intrinsic value of a fast-growing business,

other factors come into play. These factors include the current size of the businesses, under
the concept it is easier to grow faster off of a smaller base. Also, the predictability of the future
growth, or at least the perception of future growth, will affect valuation. The quality of the
company and the industry it is in are also important factors. An additional key factor would be
the total size of the market the company’s business operates in.

There are many other factors, but hopefully you get the point. Due to the power of
compounding, fast growth generates a much larger future income stream and, therefore,
higher potential future returns. The concept of capitalizing a future income stream is the key

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factor that determines true worth for all investments, especially stocks. And very fast-growing
companies generate a lot of future earnings for the market to capitalize.

The important takeaways are valuation coupled with earnings growth are important investor
considerations. Given the correct valuation, the rate of change of earnings growth is the
primary factor that generates the magnitude of future returns. But remember, it is also
important to acknowledge higher growth is harder to achieve and is, therefore, more risky. As
such, growth stocks naturally command a higher valuation than slow-growing companies.

There is less mystery in the investing process when these concepts and principles are
understood. Investing should never be a mere guessing game, nor should investors be
purchasing a “pig in a poke.” Investors that have a working knowledge and understanding of
valuation and its relationship to the company’s growth will have realistic and intelligent
expectations regarding future returns and the risk they are taking to achieve them.

FAST Graphs analysis video

There are many so-called investors who eschew reviewing historical fundamental operating
results on the notion history is merely rear-view mirror thinking or 20-20 hindsight. I believe
they are drastically short-changing themselves. Although it is true that we can only invest in
the future, it is equally true that we can learn a great deal from carefully examining the past.
Because, as Sir Winston Churchill so eloquently put it: “Those who fail to learn from history
are doomed to repeat it.”

Furthermore, it is said a picture is worth 1,000 words. If true, then how many words is a video
worth? I do not have an exact answer, but I assure you that a well-produced video analyzing a
company’s fundamental strengths and weaknesses is worth many, many more. With the video
format and utilization of FAST Graphs (the fundamentals analyzer software tool), I know I can
provide a more comprehensive fundamental evaluation and analysis than I could with a long
article comprised of thousands of words. Therefore, the following video highlights the
attractive valuation of Ulta Beauty Inc.

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2/13/2018 Peter Lynch Taught Me to Invest in Ulta Beauty - GuruFocus.com

Summary and conclusions

Ulta Beauty is a classic example of a true or pure growth stock. The company has consistently
increased its earnings at double-digit rates exceeding 25% per annum since 2009.
Furthermore, Ulta Beauty is currently available at a valuation that is low by historical
standards. Additionally, the company has a strong balance sheet and is forecast to continue
growing earnings in excess of 20% per annum over the longer run.

Even though Ulta Beauty’s current valuation is low by historical norms, however, it is currently
higher than its forecasted growth rate. Therefore, from the perspective of future returns, it
could be argued the company is moderately overvalued on that basis. On the other hand, if
the company does continue to grow earnings at a 20% rate or better, then future return
expectations would still be in the double-digits.

Nevertheless, based on future expectations, I would consider Ulta Beauty moderately

overvalued at the worst and fairly valued at best. Consequently, I would prefer picking it up at
a lower valuation. However, I believe valuation is sound enough to start nibbling and certainly
sound enough to be worthy of conducting the time and effort for a full research and due
diligence process.

Disclosure: No position.

The opinions in this document are for informational and educational purposes only and should
not be construed as a recommendation to buy or sell the stocks mentioned or to solicit
transactions or clients. Past performance of the companies discussed may not continue and
the companies may not achieve the earnings growth as predicted. The information in this

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2/13/2018 Peter Lynch Taught Me to Invest in Ulta Beauty - GuruFocus.com

document is believed to be accurate, but under no circumstances should a person act upon
the information contained within. We do not recommend that anyone act upon any investment
information without first consulting an investment advisor as to the suitability of such
investments for his specific situation.

About the author:

Chuck Carnevale
Charles (Chuck) C. Carnevale is the creator of F.A.S.T. Graphs™. Chuck is also co-
founder of an investment management firm. He has been working in the securities industry
since 1970: He has been a Partner with a private NYSE member firm, the President of a
NASD firm, Vice President and Regional Marketing Director for a major AMEX-listed
company, and an Associate Vice President and Investment Consulting Services
Coordinator for a major NYSE member firm.

Prior to forming his own investment firm, he was a partner in a 30-year-old established
registered investment advisory in Tampa, Florida. Chuck holds a Bachelor of Science in
economics and finance from the University of Tampa. He is a sought-after public speaker
who is very passionate about spreading the critical message of prudence in money
management. Chuck is a veteran of the Vietnam War and was awarded both the Bronze
Star and the Vietnam Honor Medal.

Visit Chuck Carnevale's Website

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