Sally Beauty Shares Haven't Been Pretty, but Appearances Don't Tell the Story

One of the most frustrating things in investing is being correct on your thesis yet seeing your stock just sit there, doing very little despite great fundamentals. That's been the case with Sally Beauty Holdings over the past couple years. Earnings per share for the fiscal year that ended Sept. 30, 3017, were $1.56, and fiscal 2018 EPS grew 17.9% to $1.84. Fiscal 2019 estimates, with half the year already reported, call for EPS of $2.19. You'd think the stock would be trading higher on that good, sustained growth. Instead, Sally Beauty is lower now than it was two years earlier. There was tremendous insider buying from May through November 2017 at an average cost of $17.81 per share. But as of 11:48 a.m. on May 8, Sally Beauty was trading for just $16.48. How did the shares do badly while profits grew nicely? Price-earnings (P/E) compression. Right now Sally Beauty sells for just 7.5x this year's estimate versus its normalized level of about 15.5x. That compression accounts for the stock's poor price growth persistence score (shown below) even though its other major metrics look solid. It hurts to be right yet be sitting on paper losses. That said, there's no reason to believe Sally Beauty won't revert to a more typical valuation. Bouncing back to even 15x next year's estimate would support a bounce-back to around $34.50, more than double its current quote. That goal is far from crazy. Sally Beauty topped out above $35 back in 2015 when EPS were destined to finish at $1.49, rather than the expected $2.19 for fiscal 2019. It peaked between $23.60 and $32.90 during each of the other six years from 2012 through 2018 as well. Getting back to even the lowest of those previous tops would lead to gains of more than 43% from $16.48 per share. Instead of being mad, like in the E-Trade ads, Sally Beauty's CEO and a director each bought shares again this month, cheaper than they paid back in 2017. The people who know Sally Beauty best are convinced they'll be well-rewarded for averaging down. Good things come to those who wait. The chance at a double, or better, simply on a change in mood suggests both the old and new buys eventually will turn quite profitable. Buying shares outright is the only way to capture a move of that magnitude. Option writers willing to nibble at the edges can pocket serious premiums by selling Dec. 20, 2019, expiration date puts at the out-of-the-money $15 level, to in-the-money $17.50 and $20 strike prices. With SBH at $16.48, worst-case forced purchase prices dropped to between $13.65 and $15.80. Even the most aggressive of those would get you in below where those recent insider trades took place. Future stock market action can never be guaranteed. We can know for sure, though, that owning SBH near $15 would have been a winning position almost 97% of time dating back to before the start of 2012. Earnings per share were just $1.24 in fiscal 2012, just 57% of what's expected right now. Stocks almost always revert to their normal valuations over time. Long periods of multiple compression typically give way to equally long periods of P/E expansion. Two years of frustration have allowed anyone who wanted out of SBH to sell in impatient disgust. It's time for the company's good fundamentals to be recognized in its share price once again. Buy Sally Beauty shares, sell some puts or consider doing both. Sally Beauty is one of my personal top 10 holdings by dollar amount.

Sally Beauty Shares Haven't Been Pretty, but Appearances Don't Tell the Story

It's frustrating when a stock sits there despite great fundamentals, but past valuations indicate investors eventually should be rewarded by the salon products retailer.

Columnist Conversation

Added Some Peleton

MRK and LVS Targets Coming Up

Rolling Up Apple

COLUMNIST TWEETS

Please Join or Log In to manage and receive alerts.