6 Beautiful Lessons to Learn From Ulta Beauty Amid 2020's Market Plunge

Stocks such as Ulta Beauty Inc. provide terrific lessons to learn as to what to do when the inevitable next big market sell-off occurs. ULTA is a top-quality, proven growth company. Prior to the COVID crisis few companies could match its stellar long-term improvements across all major business metrics. That enviable record helped send the shares to an all-time peak of $365.50 during the summer of 2019. Despite its incredible record, ULTA plunged briefly to south of $125 during the panic selling of March 2020. By June 2020, ULTA had bounced back a bit, to around $190. Lesson #1: When general market weakness kicks in, even the best stocks can get knocked down by huge percentages. At ULTA's March 2020 nadir it was down by more than 66% from the previous year's high. Lesson #2: One-time events such as last year's government-imposed store closings make price-to-earnings (P/E) multiples based on that year's earnings meaningless. It was better to ignore fiscal 2020 and base future price targets on normalized earnings power times a historically normalized multiple. It seemed likely that ULTA could match or exceed its old profit levels once its stores were allowed to reopen. Even a conservative rebound in earnings and a somewhat lower-than-typical P/E projection led me to believe ULTA could reach at least $276 by the end of January 2022. The graphic from my late June 2020 article on ULTA is shown below. ULTA was no stranger to sharp sell-offs followed by sharp percentage gains. This was the image I published last year illustrating its multiyear history on that score. Every painful decline was simply a prelude to an even more impressive percentage rebound. Lesson #3: Buying after major pullbacks is a low-risk strategy that offers outsize potential gains. Purchasing ULTA on June 26, 2020, more than $65 per share above its panic bottom, had provided a very fine rebound of nearly 83% by June 30, 2021. Lesson #4: You don't need to catch exact lows to get great results. I'll have more to say about this topic later on. Last June's article explained how to set up a bull call spread using ULTA as the underlying security. Bull call spreads require purchase of a call option while simultaneously shorting a higher strike price call. Typically, bull spreads employ identical expiration dates. I saw major upside potential in ULTA but was unsure of how long it might take to unfold. I thus recommended using Jan. 21, 2022, expiration dates, allowing for plenty of time for things to get back to normal. Actual option prices from June 26, 2020, with ULTA at $190.71 are shown below. The spread illustrated went long Jan. 2022 $190 strike price calls at $51.18 per share while shorting Jan. 2022 $250 strike price puts at $28.50. Cash flow details on each one contract spread are shown below. Money received from the short sale of the higher strike price call reduced the net cash outlay to just $2,268 per 100-share equivalent. Buying 100 shares of ULTA at $190.71 would have required laying out $19,071, or 8.4x more money than needed to set up the bull call spread. The best-case scenario shown will be in effect if ULTA closes on the Jan. 21, 2022, expiration day at $250 or above. That result is looking quite likely now, with ULTA already trading in the mid-$340s. We couldn't have known back then that ULTA would bounce back so strongly and so quickly. That why I also provided mid-range, break-even and worst-case scenarios that could have played out if things did not go as well as expected. Maximum risk was a loss of the entire $2,268 laid out at the start. Maximum profit was a gain of $3,732 per 100-share commitment. Here's a quick look at ULTA's three-year price movement through June 2021. ULTA reached the mid-$260s in early June of 2020. By Sept. 10, 2020, though, it had slid back to about $232. That gave traders another chance to play ULTA at a relatively attractive price. At that time, I reverted back to my favorite go-to option technique of simply selling long-term puts. ULTA's $232 stock price meant every put contract represented a fairly large dollar commitment if eventually exercised. For that reason I sold just two contracts of its deep-in-the-money Jan. 2022 $260 puts. I pocketed a cool $64.40 per share for selling those puts, lowering my worst-case, forced purchase price to just $195.60 ($260 minus $64.40). Lesson #5: Selling long-dated puts allows for worst-case purchase at prices well below what was currently available to outright buyers. ULTA hadn't been available for under $200 since July 2020. On June 10, 2021, I bought to close those two contracts for just $6.60 per share, extinguishing my obligation to buy if ULTA fell back later. The net profit of $11,557 represented 89.7% of the maximum possible gain if held all the way through expiration and obtaining the best-case scenario. My trade duration period was 294 days. Closing early allowed me to redeploy the $52,000 in imputed buying power 210 days sooner than if I'd waited until expiration. How much actual cash was required to make that almost $12,000 gain? Not one cent. All that was needed was to have enough free buying power in a margin-type account to secure the puts' margin requirement. Shorting those puts pushed my cash account balance $12,878 higher. Closing early meant giving back just $1,321 of that amount. Lesson #6: Option trades can be closed at any time (if they have not yet been exercised). Using long-term expiration dates brings in the largest premiums, yet does not commit you to actually holding those positions that long if you later choose not to. At its June 30, 2021, quote of $345.17, ULTA appeared fairly priced, at around 28.5x projected fiscal 2021 earnings per share. I'm no longer recommending it for purchase. If future market action pushes ULTA back down I'd definitely consider re-establishing new put commitments, this time using Jan. 20, 2023, expiration dates.

6 Beautiful Lessons to Learn From Ulta Beauty Amid 2020's Market Plunge

General market weakness can provide great opportunities to cash in on proven names that suffer along with the crowd.

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