Can The Rally In e.l.f. Beauty Stock Continue?

Key Points

• e.l.f. Beauty recently broke out of a continuation pattern to a new high. 
• The gains were capped, however, by a downgrade to Hold. 
• The high valuation and a weak outlook for earnings may spark a correction. 

Shares of e.l.f. Beauty, Inc NYSE: ELF has been rallying strongly on outperformance and earnings strength, but it looks like the string of higher prices could be over. The stock hit the ceiling in the 2nd week of January which belies the signal given just the week before.

The week before this stock broke out of a long-term Bullish Flag Pattern that suggested not only a continuation of the rally but a move that could have added 35% to 55% to the share prices. The underlying factor that has put a cap on the stock is the valuation and a weak outlook for the year that could leave investors in need of a makeover come the February 1 earnings release. 

Is e.l.f Beauty Worth 50X Earnings? 

E.l.f Beauty is trading at 50X its earnings which is a high valuation for the market in general but worthy for a stock growing at a sustained, high-double-digit pace. The real question is if the company is going to earn the EPS the analysts are expecting, and this is important because it could have an impact on the price multiple as well as the stock price itself.

Assuming the multiple remains the same and the FY23 EPS falls short and/or worse, the outlook dims, the stock will fall on a function of earnings. If the EPS falls short and the multiple contracts, the stock price could see an even larger decline. 

The stock rally was supported by an increase to guidance that came out with the last earnings report, the FQ2 report, and it was above the Marketbeat.com consensus at the time. The problem is that the consensus figures have been on the rise and are outpacing the company’s expectations.

The current consensus is revenue of $488 million versus the range of $448 to $456 and EPS of $1.12 versus the expected $1.07 to $1.10, which sets the bar on the high side. In this scenario, the company could outperform its guidance and still miss the consensus or produce uninspiring results at these high stock valuations. 

While e.l.f Beauty is not a mall-based retailer, a reduction in guidance from Macy’s NYSE: M could also foreshadow mixed results for this company. Macy’s says peak shopping periods were above expectations during the quarter and helped to support current quarter results, but revenue will be weak and off-peak shopping periods were dismal.

If that is a trend across the industry and continues into the lengthy non-peak January to March season, it could have an impact on e.l.f results and outlook. 

The Analysts’ Sentiment May Have Peaked 

The analysts are bullish on e.l.f Beauty, but the upward trend in sentiment may have peaked. The latest commentary came out on January 9th and is a downgrade from Buy to Hold. This is the first downgrade since the summer and has the sentiment edging lower but still pegged at a Moderate Buy.

The real concern here is that the Marketbeat.com consensus price target assumes the stock is fairly valued at these levels and there is no reason to think it will trend higher unless the company outperforms during the holiday quarter. If not, and the analyst's sentiment sours more, it will weigh on the price action. 

Turning to the chart, this stock was showing a very nice breakout, but one that occurred during overbought conditions and deep into the rally. The next week was met with a major sell-off that set resistance at $57.75.

The stock could move sideways from here and even recover its recent highs, but without a real catalyst, there is no reason for it to stay there. More likely, this market has begun to correct and could fall 20% or so down to the 150-day moving average.