The investment firm has bid up shares in Ulta Beauty, but does it make sense as a long-term holding?

If you buy shares in a cosmetics retailer Ulta Beauty (ULTA 0.09%) If you were 10 years ago, you’d be pretty happy. After all, beauty stocks have risen more than 300% in the past decade. S&P 500.

But Ulta Beauty’s stock performance so far this year is an entirely different matter: As the chart below shows, the stock is down more than 20% compared to the S&P 500’s impressive 16% gain.

Data by YCharts.

While some investors are becoming desperate, others are sniffing opportunity. For example, various hedge funds including Steelpeak Wealth have increased their positions in Ulta Beauty this year.

This isn’t necessarily breaking news: SteelPeak Wealth updated its holdings with the SEC in April. The hedge fund holds hundreds of stocks, and its $1.5 million investment in Ulta Beauty is a relatively small holding in its portfolio.

Caveats aside, SteelePeak increased its stake in Ulta Beauty by 25% in the first quarter. It may continue to increase its stake in the second quarter, but investors won’t know for sure until the latest filings are made. But it’s important to remember that hedge funds are run by investment professionals. What would a professional look for in a company like Ulta Beauty?

There’s a lot to like about this business, but retail investors may be better placed to take advantage of this opportunity.

Here are some things I love about Ulta Beauty

95% of Ulta Beauty’s revenue comes from its 43 million loyalty members. This has been the case for several years. But over time, the loyalty program’s active members have grown, and so has the average spend per user. Because this has been the case for many years, it’s reasonable to expect that Ulta Beauty’s sales will remain relatively stable, thanks to its most loyal customers.

Turning to earnings, Ulta Beauty had operating margins of 14.7% in the first quarter of fiscal 2024 (ending May 4), and management expects full-year margins of 13.7% to 14.0%. Sure, that’s down a bit from its peak a few years ago, but profitability is still good, and the debt-free company should ultimately have more cash on hand.

Finally, the stock’s valuation is attractive: its price-to-earnings (P/E) ratio is about 15, about 50% lower than its 10-year average, and significantly lower than the average valuation of the S&P 500.

Data by YCharts.

Put all this together and you’re likely to see hedge funds like Steelpeak buying Ulta Beauty shares because they believe the company has predictable revenue, above-average profits, and a cheap share price.

Why retail investors have the advantage

So, will Ulta Beauty stock recover and rocket toward new highs?

There’s no need to rush. Good stocks can be undervalued for a long time, and bad stocks can be overvalued for a long time. But eventually stock prices will reflect a company’s fundamentals, and the one thing most pros don’t have is time.

Many hedge fund professionals are under pressure to produce results quickly for their investors. Just a few quarters of poor performance may cause investors to take their money elsewhere. In contrast, amateur investors invest their own money and are ultimately responsible for themselves. They can choose to be patient and buy and hold if they wish.

Patience is a powerful ally. Looking back at Ulta Beauty, for example, their stock carries risks like any other investment. But even if we assume the company can’t grow and just maintains its current business levels, it’s still able to make over $1 billion in operating profits per year.

Ulta Beauty is debt-free, so it’s not like it owes anyone $1 billion. The company can simply reinvest it in the business, return it to shareholders, or a combination of both. Again, positive returns are not guaranteed — nothing is guaranteed in the stock market. But given enough time, it’s hard to imagine a consistently profitable company not delivering solid returns to shareholders.

This patience is one of the biggest advantages that average investors have over the pros — and it’s why you could still outperform the pros when investing in Ulta Beauty stock.