This Nike Stock Analysis discusses why Nike stock (NYSE: NKE) is not a good buy because the market is pricing in the expectation that future growth will be similar to past growth. That is very exuberant due to the concerns related to current and future growth. However, Nike stock definitely represents a great business and you never know how such stocks are going to be priced over the long term.
In this Nike stock analysis, we are going to discuss:
If you prefer watching or listening, here is the Nike stock analysis video, article continues below:
Let’s first discuss what makes Nike a great business and then discuss the stock and the investment thesis.
The 5 characteristics a great business has are the following:
Nike’s dividend has been constantly growing as the business and earnings expanded.
A growing dividend is an indication of a great business as growth comes alongside increased profits, confirming the quality of the business model. It also shows how the company has enough free cash flow to reward shareholders.
This might be counter intuitive, but a Nike’s stock low book value is another great business indicator. A low book value shows how Nike doesn’t need much capital to do business and grow where the earned money to reward shareholders.
Despite the relatively low book value, Nike is not even close to financial distress. Its Altman-Z score is far from a level below 1.81 that would indicate distress.
Great businesses have high returns on employed capital and Nike’s returns are staggering.
With high ROCE, a company that can growth revenues at high single digits, improve net profit margins over time and consequently improve earnings at teen digits, can only result in a great investment over time.
With the capacity of investing your capital with a high return, it pays to grow as fast as you can which is what Nike has been doing. Plus, apart from expanding its business, the management has been capable of expanding margins and profits even more.
Nike’s net profit margin expanded from the high single digits in the 2000s to the low teens over the last few years. Just the margin expansion ads $1 billion to profits. Further, thanks to buybacks, earnings and dividends per share grew at an even faster pace than revenues and net income which is good for the stock.
However, this was the past as it has been great. Let’s look at the future, a future that will most likely not be as great for investors as the last few decades have been.
Average revenue growth has been 6.17% over the last 5 years. It represents a significant decline from teen growth rates that were the norm in the past.
When we combine the slower growth rate with the exuberant valuation, it creates a high-risk investing situation. Let me use $3 per share as the owner’s earnings which would be a likely level for 2020 without the virus. At a price of $100, that would give a price to earnings ratio of 33. Thus, the investment returns investors can expect are around just 3%. Expectations for higher investing returns are based on growth.
Buying something with a lofty valuation just because of good growth prospects is risky because the stock gets hit very hard if the growth expectations aren’t met and we have already seen Nike’s revenue slowing down. Plus, Visa is a business that I analyzed where the expected revenue growth is 15% per year but trades at a similar valuation to Nike’s.
Nike’s issue is the slower growth rate that is around 6%. The management is trying to do what is possible to ensure at least higher earnings growth. Over the last 10 years the company has bought back around 20% of shares outstanding and consequently increased earnings per share. But, 10 years ago, the share price was below $20 which made it 80% cheaper to do buybacks and consequently improve investment metrics.
Further, the company changed its revenue recognition method in 2018. They decided to recognize revenue on shipment and not on delivery. Given that e-commerce is growing fast, recognizing revenue on shipment might keep the image of faster revenue growth as it doesn’t account for returns immediately.
Source: Nike 10K 2019
The revenue recognition change might be just curious fact, but it is one that raises an eyebrow and tells us we have to watch the amount of financial engineering the company will be doing in the future.
When it comes to investing in great businesses, the question is always whether the future will be of resemblance to the past? Unfortunately, each company has a life cycle and that, in the best scenario, a growth company turns from a fast grower into a slow growth cash machine. You can take Apple as a good example of that. The only difference is that in 2016, AAPL’s price to earnings ratio was around 10, and not above 30 like it is the case with Nike now. The high valuation is the prime risk for the company as slight changes in the market’s perception on Nike’s future growth prospects could have a high impact on investing returns.
I will personally avoid Nike and look for better risk reward opportunities even if Nike is and will definitely remain a great business. The above doesn’t mean Nike’s stock will fall. In the current ‘free money’ environment, the market might remain exuberant about the 1% dividend yield that looks amazing compared to Treasuries and slow growth ahead. I just hope that this analysis gives you a different perspective on Nike, a new factor to carefully watch and that it helps you with assessing the value of the stock to your portfolio.
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The author, Sven Carlin Ph.D. is a professional stock market researcher at Sven Carlin Stock Market Research Platform where you can find full sector and country analyses, a value investing strategy and a long-term attitude.