When you take growth into account, I don’t think I could name ten businesses that are preferable “buy and hold for the rest of your life” investments than Nike. Their growth reports are insane: orders are up 27% in China, women’s shoe sales are growing at a 17% rate, men’s shoes outside of the United States are growing at a 22% rate, the Nike store is expanding sales at almost 30%, and there is no segment of Nike’s business that is not growing at a rate of at least 10%. They were right to use the DJ Khaled song “All I Do Is Win” for their 2010 advertisements, but it’s also the song shareholders have been singing since the $2 million IPO in 1980.
The long-term results have been staggering: Since 1980, a $10,000 investment would have grown into $4.5 million for a 18.8% compounding rate; since 1990, the same amount would have grown into $551,000 for a 17.0% compounding rate; and since 2000, the same investment would have increased ten-fold to $107,000 for a 16.6% compounding rate.
You know what else I find interesting? The stock traded at 23x earnings in 2000. Even if you assumed regression to the mean, and a terminal P/E ratio of 20x earnings in 2016, you still would have ended up with a 15.2% compounding rate as the growth in earnings has been so staggering that even modest overpayment for shares soon got burned off.
By my calculations, Nike is a business that will earn $2.15 per share this year, or $2.35 per share on a constant currency basis. After hitting $67 in November and then staying around the $64 range in March, the fortuitous brand endorsements of Under Armour with Stephen Curry and Jordan Spieth has made some investors wonder whether Nike’s competitive landscape is about to get tougher. As a result, the price of the stock has come down to $53 per share.
That’s the territory where things start to get interesting. On a straightforward P/E basis, the stock is trading at 24.5x earnings. If you adjust for the effects of negative currency translations to try and get a feel for the true earnings power, the valuation is more like 22.5x earnings. That is, at most, a 10% or so premium over what you’d ordinarily consider a fair price point. It’s getting there.
In fact, it’s so close that it may still be one of the most attractive investments that you can make today. The high end of analyst estimates are calling for 18% annual earnings growth for the next five years and 13% annual revenue growth. That may sound ambitious, but that is exactly the kind of earnings reports that Nike has regularly on behalf of shareholders since the 1980 IPO.
And I’m not just talking the long-term history either. Even over the past ten years, Nike has grown revenues by 10.5% annually and has grown earnings by 14% annually. And it’s accomplished all of this without sacrificing the balance sheet. Nike recently took on $1 billion in debt, but the balance sheet is still pristine. It has $2 billion in debt obligation, and $5.1 billion in cash. It is making profits of over $3 billion per year. That puts it in the top 5% of Fortune 500 companies from a cash to debt to cash flow analysis perspective.
Would I fault someone for demanding an entry price of $43 per share before giving Nike a shot? Nope. Intelligent discipline is an important part of investing, and it can be quite difficult to figure out the difference between being a disciplined value investor compared to an investor who is penny wise and pound foolish.
A lot of times, the analysis of attractive entry points is determined by comparing the subsequent performance of the share price. If the stock falls to the low $40s, people will talk about the value of being disciplined and waiting for your price. If it doesn’t, the narrative will be about recognizing a good thing when you see it and seizing opportunities based on common sense rather than rigid formulas.
But that type of analysis is contingent upon hindsight bias, and treats as elements information that you could not have any a priori knowledge about.
For me, the question is whether you have a conviction in its expected growth rate: When you see the calls for double-digit revenue growth and earnings growth in the mid teens, do you consider that to be a highly probable estimate or something that is lower probability and more akin to a coin flip?
If you have a high level of conviction that Nike might be growing earnings in the 13% to 17% range, then you’re going to be better off buying a block of stock and watching it sail off like the generations of previous shareholders have. If you are more dubious it, then the added discipline makes sense–lower levels of conviction relating to growth ought to translate to a more attractive P/E ratio demanded by the investor.
My view is that, although the P/E ratio might look higher than people are usually comfortable paying for stocks, the brand equity at Nike is so high, the balance sheet so pristine, and the long-term earnings growth rate so attractive that it doesn’t make sense to quibble over $5-$10 in valuation if you’re going to be in it for the long haul.