In a surprising move, Warren Buffett added the cosmetics retailer Ulta Beauty (ULTA -0.04%) To Berkshire-Hathaway‘s portfolio in the second quarter. Buffett is not afraid to have retailers in his portfolio, holds Walmart He held shares for over 20 years before exiting the position in 2018. However, in recent years it has no longer been the focus of his interest.

The only other retailers currently in Berkshire’s portfolio are e-commerce giant Amazon and flooring and tile dealers Floor & DecorBuffett previously owned the furniture retailer SECTION HR-VHowever, the stock was sold out at the end of 2022.

Let’s look at what might have attracted Buffett to Ulta stock.

1. Low rating

Berkshire bought Ulta stock cheaply in the second quarter – during which time Ulta’s share price has fallen 33% year to date. Of course, it has recovered some since Berkshire’s purchase was announced, but the stock is still down about 20% year-over-year and currently trades at a price-to-earnings (P/E) ratio of 13.

ULTA P/E (1 year forecast) data from YCharts

That’s a big discount from where the cosmetics retailer has traded in recent years. Buffett and his team love a bargain, and they obviously thought Ulta’s stock had ended up on the bargain table.

The stock has come under pressure this year, largely due to increased sales of prestige brands both in-store and online. This prompted Ulta to lower its revenue and operating margin forecast for the year. However, Berkshire’s investment team must believe that these current headwinds are manageable.

2. A resilient and growing category

The beauty category overall continues to grow well. The category has experienced rapid growth over the past three years, and growth is expected to continue, albeit at a more moderate pace. Ulta, for its part, expects the category to grow in the mid-single digits this year. As the largest beauty specialty retailer in the country, Ulta is benefiting from this category growth.

At the same time, beauty has historically been one of the most recession-resistant categories. This phenomenon has become known as the “lipstick effect,” which economics and sociology professor Juliet Schor first described in her 1998 book. The over-indebted American. Schor found that during economically tight times, women spent money on small luxuries like lipstick. This theory has been borne out in several recessions since then, including during the Great Recession, when cosmetics sales rose while other categories like clothing saw sales decline.

During the pandemic, that spending shifted more to moisturizers and perfumes as people wore masks, but spending remained in the beauty category. With recent signs of consumers beginning to slow down, spending on perfumes and lipsticks has skyrocketed. According to AdobeOnline sales of perfumes increased by over 19% from January to May this year, while online sales of lipsticks increased by over 37% during the same period.

3. The category leader

A hallmark of Ulta’s business model is that the company sells beauty products across a broad price range and offers both luxury, prestige and mass-market brands in a single store. This gives the company one of the best assortments for shoppers while also being able to serve customers of all income levels.

It also attracts younger customers to its stores, allowing them to upgrade to prestige brands as they earn more, and it allows customers to mix between mass and prestige categories. For example, it would not be unusual for a customer to buy a high-end skincare product while also buying her favorite lipstick from Elf Beauty. According to Circana, over 90% of prestige beauty brand shoppers also buy mass products, while 35% of mass shoppers will buy a prestige brand. At Ulta, they can do it all in the same store.

4. Accelerate growth

Despite near-term headwinds, Ulta has several levers it can pull to fuel growth. The company has one of the strongest loyalty programs in retail, with 95% of its sales coming from loyalty program members. This gives the company a tremendous amount of data to use to target additional advertising and special offers to its customers.

Although distribution of prestige products has increased, there is no other retailer that can offer Ulta’s assortment across all beauty categories. Ulta is also adding new and popular brands to its assortment and plans to add at least 25 new brands to its assortment this year. The company also plans to increase its social media presence and increase collaborations to increase customer traffic in its stores and online.

And while the company isn’t expanding its store base quickly, it still plans to open between 60 and 65 new locations this fiscal year. That represents 4 to 5 percent growth in store count, which is solid.

Image source: Getty Images

Overall, it’s easy to see why Buffett and his team were attracted to Ulta. With the stock still cheap, it’s not too late for investors to buy shares.