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Eye of the Beholder: Would You Invest in These Profitable Beauty Stocks?

Mary-Lynn Cesar, Kapitall: Will investing in these profitable beauty stocks be good news for your portfolio?

January has been a mix of bad and good news for beauty stocks.  Earlier this month, both Revlon (REV) and L’Oreal (OTC:OR:FP) announced plans to trim their operations in China due to underperformance. Revlon will exit the country completely, cutting approximately 1,100 jobs, whereas L’Oreal will cease to sell its Garnier line, which was introduced to the Chinese market in 2006.

However, not all of the news coming out of the beauty industry is bad. Japanese makeup giant Shiseido (OTC: 4911) released its financial results report for the first three quarters of fiscal year 2013 today, and the company reported a 267.2% year-over-year increase in net profit.

Read more about growth in beauty from Kapitall: 3 Rallying Beauty Stocks With High ROE

For the nine month period ending December 31, Shiseido generated $168.65 million (¥16.75 billion) in comparison to the $45.93 million (¥4.56 billion) posted during the same period in fiscal year 2012. The company also revised its outlook for the entire year in the report, raising its projected net profit by 26.7% to $185.44 million (¥19.0 billion) from its previous forecast of $146.4 million (¥15 billion).

Investing ideas

Shiseido's soaring net profit inspired us to take a closer look at profitable beauty stocks publicly traded on US exchanges. We began by constructing a universe comprised of personal products companies, limiting our list to firms that offer beauty products.

Next, we screened for stocks that have a profit margin greater than the industry average. Profit margin tells how much money a company keeps in earnings out of each dollar it makes in sales. For example, the profit margin industry average for personal products is 9.36%; if a company has that as its profit margin, it means that the company has a net income of $0.0936 for every $1 of sales. Profit margin is calculated by dividing net income by sales.

We then ran another profitability screen, this time looking for stocks with a healthy return on equity (ROE) greater than the industry average. ROE measures a firm's profitability by expressing a company's profits as a percentage of shareholder equity.

For our last screen, we further narrowed down our list by only including those with return on assets (ROA) higher than the industry average. ROA is a performance metric that assesses a company's ability to use its assets to generate earnings. It is calculated by dividing net income by total assets (debt and equity). A company can use its assets to finance its operations, so when a stock has a high ROA, it shows that the company is efficient in using its assets to make investments that earn significant amounts of money.

We were left with three profitable beauty stocks on our list.

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