Three Undervalued Retail Stocks the Market Keeps Missing — Ulta, Sprouts, and Nike

Retail is boring — that's the opportunity

Three of my seven picks run on bricks and shelves. They aren't glamorous. That's exactly why I think they're mispriced.

The shared grammar across all three: high returns on capital, new stores that still earn good returns, and a brand you can't copy overnight. I'm not betting on a revenue explosion. I just need each business to keep compounding naturally while the market eventually pays up. Let's take them one at a time.

1. Ulta Beauty — recession-resistant beauty leader at 16x free cash flow

Ulta is the largest beauty retailer in the United States. Bottom line first: you can buy a high-return, high-quality business at 16 times free cash flow.

It's a one-stop shop for makeup, skincare, hair, fragrance, and salon services, and more than 44 million loyalty members keep coming back. Beauty is also one of the most recession-resistant things people buy — even when money's tight, folks protect their self-care.

There's news this quarter, too. Ulta is winding down its store-inside-a-store deal with Target, but just teamed up with Bath & Body Works to put candles, scents, and body care in 600-plus Ulta stores starting in July.

Now the numbers. Market cap is roughly $20 billion, enterprise value $23.8 billion — that ~$4 billion gap is net debt. For a company with this many locations, carrying only $4 billion in debt while generating $1.22 billion in cash flow last year is very comfortable. It trades at 16x free cash flow, with a 40% gross margin and a remarkably steady net margin around 10% over the past decade. That's a combination I like.

Analysts see EPS growing from $26 this year to $59 in eight years — more than double, about 10% a year — with revenue climbing from $12.6 billion to $20 billion. I plugged in revenue growth of 3/5/7%, net margins of 9.5–11%, a 10-year-out P/E of 17/19/21, and a 9% required return. At today's $450, that gives a low of $450, a high of $816, and a mid of $610 — roughly a 13% annualized return on the middle case.

2. Sprouts Farmers Market — private label is lifting the margin

Sprouts is a specialty grocer for people who actually read ingredient labels. Here's the key: it already earns several times a normal grocer's margin, and its own private label is pushing that margin higher.

It runs 480-plus stores across 25 states and did about $2.3 billion in sales last quarter. A typical grocer like Kroger nets 1–2%; Sprouts nets 4.2% over ten years and 5.7% over the last one. Part of the secret is private label: overall gross margin is 39%, but its own brands run around 60%. The more of its own brand it sells, the higher the blended margin goes. I think this business can reach a 6–8% bottom-line margin — huge for a grocer.

The store economics are attractive too. A new store costs about $3 million and earns roughly 20% once it stabilizes, which is why management wants to nearly triple the store count.

Let me be honest about the risk. There's a securities-fraud class action targeting the CEO and CFO, and that was a big driver of the stock's fall. That's not something to wave off. Same-store sales also dipped slightly.

My assumptions: revenue growth of 4/6/8%, margins of 5/6/7%, a P/E of 16/19/22, and a 9% return. At today's $88 that produces a low of $80, a high of $187, and a mid of $125.

3. Nike — down 80%, but the brand moat is intact

Nike is down more than 80% from its 2021 peak — the biggest drop in company history. Even so, my question is simple: will Nike exist and be bigger 20 years from now?

KeyBank recently downgraded it, saying the turnaround is taking longer than hoped, with China and Europe still soft, and there's a new CFO coming over from Pfizer. The financials show why the market is scared. Free cash flow collapsed from a 5-year average of $4.35 billion to about $1 billion as the company cleared out bad inventory, and a ~$15 billion debt load with a dividend that eats $2.4 billion meant it had to dip into cash to fund the payout last year. Net margin slid from a 10-year average of 9.6% to 4.84% over the last year.

But there's a good tell: in the latest quarter, gross margin jumped from 40.8% to 49% once Nike stopped dumping inventory at steep discounts, and its wholesale numbers are improving year over year.

My honest opinion: Nike should cancel the dividend and buy back its cheap stock instead. I know that's unpopular, but if you believe the shares are cheap, it's the right move. My assumptions: revenue growth of 2.5/4.5/6.5%, margins and FCF margin of 9/9/10%, a P/E of 19/22/25 (reflecting high returns on capital), and a 9% return. At today's $42 that gives a low of $48, a high of $87, and a mid of $65 — about a 15% annualized return including the dividend.

The one line that ties all three together

Ulta, Sprouts, and Nike share one trait: they look like boring retail, but they're quality businesses that allocate capital well.

I didn't even assume much growth. When you plug in roughly half of analysts' revenue estimates and still get double-digit expected returns, that tells you the margin of safety is thick. Heads I win, tails I don't lose much — that's the setup I'm always after. Why I chose these over the Mag 7 is laid out in the personal Magnificent 7 story.

FAQ

Q: Isn't retail a dying business losing to Amazon and online?

A: Retail as a whole, maybe — but these three sit in areas that are hard to replace online. Beauty is a try-it, smell-it experience; fresh food runs on in-store trust; and Nike's moat is the brand itself. On top of that, Ulta and Sprouts are still opening profitable new stores, which tells you the physical demand is very much alive.

Q: Which of the three carries the most risk?

A: In the short term, Nike. Free cash flow has collapsed to about $1 billion and the dividend is eating into cash. That said, it's also fallen the most (80%), so if margins simply revert to historical levels, it has the most room to recover. Sprouts carries a separate risk in the securities-fraud suit against its CEO and CFO.

Q: Can you just tell me which one to buy right now?

A: That's not the point of this piece. Instead of handing you a pick, I'm showing you the process of setting assumptions and calculating value. The whole idea is for you to reach your own conclusion the same way.