The adult hair follicle dermal papilla (DP) and dermal sheath (DS) cells are developmentally active cell populations with a proven role in adult hair follicle-cycling activity and unique inductive powers. In stem cell biology, the hair follicle epithelium has recently been the subject of a great deal of investigation, but up to now, the follicle dermis has been largely overlooked as a source of stem cells. Following the sporadic appearance of muscle, lipid and bone-type cells in discretely isolated follicle DP and DS cell primary cultures, we demonstrated that cultured papilla and sheath cell lines were capable of being directed to lipid and bone differentiation. Subsequently, for the first time, we produced clonal DP and DS lines that had extended proliferative capabilities. Dye exclusion has been reported to be an identifying feature of stem cells; therefore, clonal papilla and sheath lines with differing capacity to exclude rhodamine 123 were cultured in medium known to induce adipocyte and osteocyte differentiation. Both DS- and DP-derived clones showed the capacity to make lipid and to produce calcified material; however, different clones had varied behaviour and there was no obvious correlation between their stem cell capabilities and dye exclusion or selected gene expression markers. As a highly accessible source, capable of being discretely isolated, the follicle has important potentially as a stem cell source for tissue engineering and cell therapy purposes. It will also be interesting to compare follicle dermal stem cell properties with the broader stem cell capabilities discovered in skin dermis and investigate whether, as we believe, the follicle is a key dermal stem cell niche. Finally, the discovery of stem cells in the dermis may have implications for certain pathologies in which abnormal differentiation occurs in the skin.