I was going through some old notes taken by investors that had visited California for Charlie Munger’s old meetings with WESCO shareholders that he would host annually before Berkshire Hathaway fully took it over, and one of my favorite back-and-forth exchanges occurred when an investor asked Munger why the philosophy of Benjamin Graham—namely, buying mediocre companies selling at deep discounts—never caught fire with him.
In his reply, Munger said it would quickly grow tiring “dealing in crap” and it would be much more fun owning something with a strong franchise value that retains profits and has the ability to permanently charge premium prices. This part is the critical reason why Coca-Cola, Colgate-Palmolive, Clorox, Hershey, Heinz, and PepsiCo shareholders have made so much money consistently over the years. They make people rich not just because there is the standard gap between what it costs to produce the goods and the price at which they sell them, but there is a premium price above that standard retail price as well. That extra bit of cost in each soda, mac and cheese, or oatmeal, is insignificant on an individual basis until you start to multiply it across billions of goods mixed with shares bought, held, and reinvested over the decades.
One company, whose endurable moat I have recently come to appreciate, is that of Nike. It fills an important niche role for diversification purposes—much like Disney and Tiffany Co. in which it is in a class of its own (I’m reserving my thoughts on Under Armour for the time being) where you can’t really buy something else that fills the clothing portion of a stock portfolio—and it has been one of the most unstoppable companies when it comes to retaining earnings, plowing them into new projects, and achieving favorable returns.
This is one of those stocks where the qualitative and quantitative analyses are both impressive; common sense and math are in union. If you are an obscure college athlete—a backup punter on a Division II football team—you will get completely swamped with free Nike gear. T-shirts, long sleeves, shorts, headbands, shoes, you name it. The advertising angle of Nike is all encompassing—they dominate the airwaves, sign popular athletes and nationally renowned coaches to lucrative sponsorship deals, and maintain the most prominent space at America’s houses of retail through sheer ubiquity.
The obvious strength of Nike’s long-term marketing success with athletic apparel shows up on the balance sheet over the years as well—profits of $0.54 per share in 2001 have grown to $3 now—a nice sextuple over the past decade and a half. The path upward has been generally uninterrupted—earnings grow every year, and Nike’s worst performance came through 2008 to 2009 when profits “only” grew from $2.72 to $2.76.
The dividend has been a secondary consideration to earnings growth. The Nike Board didn’t take raising the dividend seriously until 2002, but has raised the dividend every year since so that shareholders have gone from collecting $0.12 annually in 2002 to collecting $1.12 annually now. Based on $3 in profits, the current dividend still only accounts for 37% of profits.
The corporate record of wealth creation has been smashing: Since 1980, a $25,000 investment in Nike has compounded at 19.2% annually, ending up with $10 million. Since 1990, the compounding rate has been 17.4%, turning $25,000 into $1.2 million. Since 2000, Nike has compounded at a 18.7% rate to turn $25,000 into $291,000. Even over the shorter term, Nike has turned each dollar invested since 2006 into $4.84, so that $25,000 would grow to over $121,103. Basically, Nike pays out a dividend, keeps 60-70% of profits on hand to reinvest, earns 25% returns on its reinvestment projects, and then merrily grows profits along at a rate of somewhere between 15% an 20% annually.
Everything seems to have a catch, and Nike is no exception. The valuation of Nike right now is at 31x profits. That’s not good—this is a stock that every year between 2001 and 2013, you had an opportunity to buy at somewhere between 15x and 21x profits. This is the worst-time to buy Nike stock since the dotcom highs in 1998 when Nike was similarly valued (although, in a testament to the strength of Nike’s long-term business model, an investor that paid 32x profits in 1998 for Nike stock still compounded wealth at 16% annually compared to an S&P 500 index investor that compounded at 6% so ended up doing better than the best hedge fund managers net of fees anyway).
Most of you are familiar with Warren Buffett’s twenty hole-punches construct in which he mentions that we’d be better investors if we only got to make twenty important investing decisions in our lives. I am coming around to the thought that buying Nike at 20x profits or below deserves one of those twenty punches. When you study the company thoroughly, you will find it has very few peers when it comes to high quality and a simultaneous ability to convert each dollar you have to invest into a higher net worth with a certain quickness.