Would you rather a cat scratch your bum or a hamster hang off your face?

That was the insightful answer my five year daughter provided when I asked the women of the household their opinion on Bare Escentuals, Inc. (BARE). Once the laughter died down my partner gave this less amusing, but clearer response for those who can’t interpret the thought patterns of a five year.

Makeup is a tough market to crack. It is both:

• Oversupplied and
• Dominated by companies with massive marketing budgets.

Can BARE prosper?

• Makeup is prone to fads. BARE is a one dimensional company. If mineral cosmetics are a fad BARE will head to zero.
• It was popular, then died back and now is gaining some traction again.
• BARE has nothing to make me sure it will become a market leader.
• Minerals. It’s all the same stuff. Anyone can crush minerals and market it.

Without diving deeper it seems clear that there are large risks associated with an investment in BARE. Though from the low PEG that was already pretty obvious!

Taking a quick look at Bare Escentuals 8K Q2 2008 press release I note the following:

• Income statement looks good. Earnings were above expectation and show good growth.
• Inventories have ballooned. Danger Will Robinson! They did provide some reasons for this in their conference call but it is still not a good sign.
• Receivables are up. They’re even higher than end of 2007 when the revenue was higher.

Still waiting on the cash flow.

They have lowered forward guidance. Optimists might say they have set the bar low, while to me this is another warnings flag. Bad things often come in three. Another lowered guidance or even a failure to beat this lowered guidance will be very damaging.

For now I’ll place BARE on my watchlist. Despite the attractive 3:1 return to risk profile offered by this possible over-reaction to lowered guidance there are too many risks and warning flags associated with BARE for it to earn a place in my portfolio.

Associated Posts
Bare Escentuals, Inc. Part One
Bare Escentuals, Inc. Part Two Research Links
Bare Escentuals, Inc. Part Three Waiting on Cash Flow