Ulta’s Post-Earnings Gap: Bullish Or Bearish? – Ulta Beauty, Inc. (NASDAQ:ULTA)

Due to Ulta Beauty (ULTA) popping on earnings, some who took my recommendation to buy before the earnings report are holding a highly profitable position:

(Source: Exposing Earnings chat)

Exit on the Up Gap

While I recommended my subscribers exit the position on the day of the up gap, not everyone always does. After earnings, it’s best to look at the gap and analyze the earnings report so as to get a grasp on where the stock is headed. We will do both of these things here, and I’m hopeful the analysis will be useful both to my earnings trading subscribers and those looking to get in/out of an ULTA investment.

Let’s start with the gap. The recent earnings gap puts ULTA up 9%, putting the stock on track for its mini-bull season, which begins in March and ends in June. During this period, ULTA typically rises 12%, with the gains following a logarithmic pattern (i.e., most of the gains are made at the beginning of the period):

Ulta's Post-Earnings Gap: Bullish Or Bearish? - Ulta Beauty, Inc. (NASDAQ:ULTA)

(Source: American Bulls)

However, the size of the gap is not significantly outside of ULTA’s trading region, hinting that this gap might be an area gap. That would imply a pullback before ULTA continues moving upward (which itself is a separate analysis, one helped by the sentiment analysis we will perform later). However, the red-white candlestick pattern on an up gap typically corresponds to a breakaway gap, which implies further upside.

Backtesting the Gap

So which is it? The best way to answer this is via backtesting. Unfortunately, gaps of this type are rare for ULTA, giving us limited predictive ability:

Ulta's Post-Earnings Gap: Bullish Or Bearish? - Ulta Beauty, Inc. (NASDAQ:ULTA)

(Source: Damon Verial; data from Yahoo Finance)

In the chart above, we have the returns for trading this gap in the long direction over three days. While most trades were successful in producing excess returns, we have significant drawdowns, the most recent of which corresponding to a market correction. We can bootstrap the data by relaxing the definition of this particular gap in the algorithm’s code.

The results show that this type of gap on ULTA is difficult to predict. This is why we always backtest gaps instead of relying on the general gap trading theories (while I created these theories via the results of backtests over the whole market, some stocks have their own personalities and do not conform to the average). I consider this an untradeable gap:

Ulta's Post-Earnings Gap: Bullish Or Bearish? - Ulta Beauty, Inc. (NASDAQ:ULTA)

(Source: Damon Verial; data from Yahoo Finance)

Thus, gap analysis, which is highly useful both in determining whether to exit earnings trades and in predicting the short-term direction of a stock after a significant price movement, fails us in this particular situation. I knew of this before with regard to ULTA, as we have traded this stock frequently in the past, and I therefore suggested earnings traders exit their positions on the day of earnings. Indeed, last year’s report showed an area, not breakaway, gap, despite an influx of cash:

Ulta's Post-Earnings Gap: Bullish Or Bearish? - Ulta Beauty, Inc. (NASDAQ:ULTA)

(Source: Stockcharts.com)

However, that does not help those still holding.

Sentiment Analysis

Sentiment, however, does help. Management sentiment on earnings is statistically informative for predicting a stock’s movement in the following quarter. Via financial lexical analysis, we can get a feel for management’s outlook and compare that sentiment to past earnings reports.

The results of my analysis show that management sentiment remains highly optimistic. Sentiment is up 11% quarter-over-quarter and down 9% year-over-year. These are small numbers and do not imply much, but the story comes together when you note that sentiment is 63% higher than the average earnings report (for the general market).

ULTA management’s optimistic sentiment has corresponded to the stock’s outperformance. We can reasonably expect the continuation of ULTA’s upward momentum. Here are some of the optimistic forward-looking statements flagged in my analysis:

“We found more winners in the back half of the year and that drives traffic, whether it’s online or in-store.”

-With regard to driving traffic to stores and online, management points to previously unwieldy programs that are now paying off and creating traffic momentum, which implies a positive, increasing ROI for these expansions.

“Our Ultimate Rewards Loyalty program remains one of our most valuable assets… As we anniversaried the launch of our lead diamond tier (ph), we are pleased to see the number of guests that attain diamond level was ahead of plan with very high guest engagement.”

-Loyalty program both successful and performing above management’s expectations. The program’s growth is up nearly 15% year-over-year.

“This performance reflects an acceleration in the retail comp, primarily driven by traffic, continued strength in mass cosmetics, boutique brands, skincare and fragrance, and stable performance in prestige cosmetics.”

-All business categories are stable or growing as a result of ULTA’s focus on its traffic generation methods.

“Benefiting from our holiday marketing campaigns Q4 brand awareness maintain all-time high levels reached throughout 2018 at 55% for unaided and 90% for aided awareness.”

-Positive results from brand awareness campaigns, resulting in almost 100% awareness for aided tests.

“Morphe recently launched its Fluidity Foundation in 600 doors featuring 60 shades, and we also just launched a Morphe makeup fresh collaboration with Jeffree Star, another high profile social media influencer with a 11.5 million Instagram followers.”

-Copy-pasting methods that have proved profitable for the company (i.e., leveraging celebrities and their online followings). Should results be similar, this again implies excess returns in 2019.

“We enjoyed the strongest traffic in several quarters with transactions up 7.1%, and ticket up 2.3% for the total company.”

-All-time high in traffic.

Conclusion

Overall, sentiment is optimistic as a result of successful collaborations, brand awareness, and traffic-driving campaigns. The company is seeing strong growth, which is not showing signs of peaking or even slowing. Cash flow, too, is strong. Here are the running averages for the annual data:

Ulta's Post-Earnings Gap: Bullish Or Bearish? - Ulta Beauty, Inc. (NASDAQ:ULTA)

(Source: Damon Verial; data from ADVFN)

Ulta's Post-Earnings Gap: Bullish Or Bearish? - Ulta Beauty, Inc. (NASDAQ:ULTA)

(Source: Damon Verial; data from ADVFN)

Assuming the company continues to grow at this rate, the stock should move with it. ULTA does react quite rationally to growing earnings, which is not true for all stocks:

Ulta's Post-Earnings Gap: Bullish Or Bearish? - Ulta Beauty, Inc. (NASDAQ:ULTA)

(Source: Damon Verial; data from ADVFN)

Factoring in ULTA’s growth rate, we can expect a $377.14 ULTA before Q3 2019. However, whether to buy immediately after the earnings gap is an individual choice. In the long run, because of the lack of post-gap pattern, your entry time is not particularly important. If I had to make a guess, I’d say ULTA will pull back a bit this week, as the week after March triple-witching week tends to be one of pullbacks and stagnation, historically.

In any case, ULTA presents stable growth, strong upside, and remains one of my favorite long earnings plays during specific quarters in the year.

Exposing Earnings is an earnings trade newsletter (with live chat) that is based on statistics, probability, and backtests. My models are unavailable anywhere else online, as I designed them myself, keeping the code private for Exposing Earnings subscribers and myself. If you want a definitive answer on which way a stock will go on earnings, the probability of the prediction paying off, the risk/reward of the play, and my specific options strategy for the play, click here.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.