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Beauty and cosmetics retailer Ulta Beauty (ULTA -0.02%)The stock’s performance over the past six months has been anything but pretty. Slowing growth and falling profit margins have caused the stock to falter; shares have fallen from almost $600 to under $400 in the past six months alone.

Although the stock had reasons for its decline, the stock market often gets overzealous. There is a solid argument that the sale of Ulta Beauty too farand shares are poised for a strong rebound. Here’s why Ulta Beauty is a good buy for investors right now.

Why did the stock fall so much?

Beauty and cosmetics are an integral part of culture not only in America, but worldwide. Ulta Beauty is the largest cosmetics retailer in the United States, with 1,395 stores and an e-commerce store. The company sells tens of thousands of products from hundreds of brands. Ulta has also become a full-fledged brand, interacting with its customers through social media and loyalty programs.

Ulta had only 449 stores in 2011. The steady opening of new stores has fueled relatively uninterrupted sales growth for years, except for the pandemic, which hurt virtually every company with physical stores. Continuous, profitable growth has made Ulta Beauty a market leader; the stock has S&P500 approximately 3:1 since the company’s IPO in 2007.

Consumers had a lot of money to spend on the pandemic, which boosted Ulta’s business. But that tailwind has faded. Sales growth has steadily slowed since its peak in 2021, while gross profit margins peaked in late 2022:

ULTA Gross Profit Margin Chart

ULTA Gross Profit Margin – Data by YCharts

Management cites increased theft and lower-margin sales as reasons for the margin pressure. This is understandable, as consumer savings rates have fallen below pre-pandemic levels. Of course, a retailer will struggle if shoppers have less money and switch to cheaper brands. As much as people try to maintain their beauty routine, cosmetics are ultimately a discretionary budget item.

It’s not all bad

The good news is that Ulta Beauty’s recipe for success has been working for many years and there is little reason to believe that it will not continue to do so.

The company continues to open new stores and remodel existing locations. Management forecasts 60 to 65 new store openings and another 40 to 45 remodels in 2024. New stores will increase the total number of locations by 4% to 5%, essentially providing the company with low-single-digit revenue growth.

Renovations and a possible recovery in consumer numbers are expected to boost sales at existing stores. Analysts expect Ulta Beauty’s long-term sales growth to average between 5 and 6 percent per year.

ULTA Free Cash Flow Chart

ULTA Free Cash Flow data by YCharts

Ulta Beauty’s margin declines aren’t necessarily a cause for panic. Today’s gross margins of 38.9% are still significantly higher than pre-pandemic levels, when Ulta’s margins were around 36%. The company’s free cash flow is still within striking distance of decade highs, which should also fuel future share buybacks. The company has reduced its share count by 26% over the past decade, which contributes to earnings per share growth.

Ultimately, investors will have to decide whether Ulta Beauty can continue to deliver long-term growth. There is nothing to suggest it can’t.

Sales have progressed far enough

The market has been aggressively selling off Ulta Beauty shares in recent months, and the stock has become cheap. The company has had an average price-to-earnings ratio of 32 over the past decade. Today, Ulta Beauty trades at just 15 times its expected 2024 earnings – less than the half its long-term average rating.

It would be understandable if Ulta Beauty’s business was severely damaged, but as discussed, that doesn’t seem to be the case. Moreover, analysts are optimistic and expect the company to grow its earnings by an average of over 12% per year over the long term.

There’s a famous saying that the stock market can be irrational at times. This saying works both ways, meaning stocks can get remarkably expensive or cheap depending on the whim of Wall Street. Ulta Beauty has gone out of style, and the market has taken advantage of some legitimate short-term speed bumps to unfairly sell the stock down.

At this price, the stock is a bargain, making it an attractive buy for long-term investors who are willing to wait for these challenges to subside.

Justin Pope does not own any stocks mentioned. The Motley Fool owns and recommends Ulta Beauty. The Motley Fool has a disclosure policy.

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