e.l.f. Beauty has soared 143% this year. Is it too late to buy the stock?

Nvidia ($NVDA) and other AI stocks have stolen the show this year, but there are other less hyped-up names that have delivered stellar returns as well. e.l.f. Beauty ($ELF) stock is one of them. ELF has smashed the market this year with a rally of over 140%, driven by its impressive financial performance.

The company is rapidly gaining market share in the massive beauty and skin care markets, its growth is accelerating, and profits are soaring.

ELF's future prospects are exciting, as its products resonate with consumers, and the company is still small compared to global beauty giants. Yet, its social media-focused growth strategy is a double-edged sword, as negative publicity can spread as fast as positive publicity and can severely impact the company's growth. Let's see what the future holds for this up-and-coming beauty brand.

Premium at Affordable Prices

e.l.f. Beauty is a relatively new beauty brand. It was founded in 2004 with a simple mission of making prestige-quality beauty products for every eye, lip, and face – at an affordable price. At the time of its launch, most of e.l.f.'s products cost between $1 to $3.

In its first decade, the company experienced a period of steady growth, expanding its product line, opening its own retail spaces, and finding some success in digital marketing. But by 2018, e.l.f. was experiencing a plateau in sales, and the stock lost more than 60% of its value that year. In 2019, the company shifted its marketing strategy to focus on TikTok's user base (which was overwhelmingly Gen Z), leveraging short-form video and user-generated content.

The word-of-mouth marketing strategy has paid off handsomely. In 2019, the company went viral on TikTok when the hashtag #elfcosmetics gained over 3 million views even before the company had its own presence on the platform. In 2020, e.l.f. went viral again when its #elfMagicAct marketing campaign earned more than one billion views in three days.

e.l.f. has become extremely popular on social media because of its affordable prices and vegan, cruelty-free products that resonate with Gen Zers. As you can see below, e.l.f.'s products across different categories are much cheaper than competing products in the prestige category. The company is able to offer premium products at affordable prices as it has outsourced the production to China, while its direct competitors have manufacturing facilities in expensive markets like the US and Europe.

e.l.f.'s affordable prices and premium quality are helping the company gain market share and win in the current uncertain environment, as customers are switching from more expensive brands. Over the past twelve months, e.l.f.'s market share in the color cosmetics category increased by 2.6%, while all the other major brands lost market share. This shows that e.l.f.'s products resonate with the new generation, and the affordable prices attract competitors' customers, helping the company rapidly gain market share.

Financial Performance Reflects the Power of Social Media

e.l.f.'s revenue growth has been accelerating for the past four years, which is an impressive accomplishment. As you can see below, in FY19, revenue grew by only 3%. That year, the company shifted its marketing strategy, focusing on social media. The successful marketing campaigns and the user-generated content boosted the company's brand awareness, resulting in increasing consumer demand and, as a result, accelerating sales growth.

e.l.f. is now experiencing the snowball effect. Its social media success organically attracts more customers, generating more engagement and, ultimately, more sales. In the most recent quarter, sales surged 76% y/y to $216 million, blowing past analyst estimates and highlighting the strong growth momentum. The company saw strong growth in both skincare and cosmetics verticals and significantly raised its full-year growth outlook to 37% from just 23% in the previous outlook.

The company's growth momentum is clearly very strong, driven by word-of-mouth marketing through social media. This type of growth strategy is efficient and profitable, which is how the company was able to achieve super-fast growth by spending only 16% of its revenue on digital marketing during the quarter.

e.l.f. is not only growing rapidly but it's also expanding its already-high margins. In Q1 FY24, the gross margin increased to 70.5%, from 67.7% in the year-ago quarter, due to lower transportation costs and innovation with higher margin rates. The gross margin improvement and the operating leverage helped the company increase its before-tax quarterly income by 212% y/y to $59.6 million in Q1, which came in nearly twice as high as expected and the company raised its full-year profit outlook by 32%.

What About Valuation

ELF's valuation has soared over the past twelve months due to the rapidly improving financial performance. As you can see below, ELF is now by far the most expensive beauty stock at a PS ratio of 11.2x.

The stock can sustain its premium valuation if the growth momentum continues, but if growth unexpectedly slows, the stock could plunge. Beauty brands that rely on social media marketing like ELF can rapidly rise in popularity, but negative publicity can destroy them within months. Olaplex's ($OLPX) rise and fall from grace is a great example of how fast a beauty brand can collapse when negative publicity spreads through social media. As a social media-first brand, ELF is facing the same risk, meaning that the current valuation may be fair but it’s risky.

What Else

ELF management has executed flawlessly and has transformed the company from a niche beauty brand into a global giant. The company's premium but affordable products and ethical practices help it steal market share from legacy beauty brands. Its products and social-media-first strategy resonate with Gen Z-ers, driving rapid growth in a competitive industry.

While the stock is richly valued, the company deserves a premium valuation due to its stellar fundamental performance. If the growth momentum continues, the stock can rise even more in the near term. Yet, investors should pay close attention to the company's social media presence and user-generated content for potential signs of product quality issues that could damage the company's reputation.

I've no positions in the stocks mentioned.  

The boring Disclosures: Newsletters express the opinion of the authors. Nothing in this email is a buy or sell recommendation. I'm not a financial advisor; make your own decisions.