In the past week, the investor class seems to have turned sharply negative towards Nike stock. I suppose that this sentiment shift is inevitable whenever the question “What have you done for me lately?” can yield a disappointing answer. In the past year, the stock has fallen 26% from $68 to $50. It has provoked an article from Richard Suttmeier to declare “Nike reports earnings as the worst dow performer of 2016. Shares of Nike have been kicked into bear market territory.” And another writer at Seeking Alpha declared: “Nike: Just short it.”
Rather than fixate on price, I recommend that investors actually look at what the business itself is doing. In the case of Nike, it is doing what it nearly always does. And that is, deliver double-digit annual per share earnings growth to shareholders. It made $1.85 per share in profits last year. It is going to make around $2.15 per share in profits this year. That is annual earnings per share growth of 16%.
If you are darn lucky, you might have an ownership stake in five to ten business operations that are growing faster than that. Most likely, if you are a direct shareholder of Nike, I would wager you probably don’t have four or five investments growing at a faster rate than this. When adjusted for the very high earnings quality of the business, the growth is all the more impressive because it is creating wealth in a low-risk manner.
So why isn’t the stock price similarly ebullient? Because the stock price jumped too much between 2014 and 2015. It went from $34 to $68, a doubling of share price in less than one year’s time. That wasn’t warranted. That said, Nike still delivered phenomenal returns of 24% during the 2014-2015 comparison period. The issue was that the jump in sentiment vastly exceeded the jump in earnings.
At the $68 per share price point last year, the P/E ratio of Nike stock was practically predestined to come down. It was a P/E ratio of 36x earnings. It was nearly certain that the valuation needed to recalibrate itself at a lower level. Sometimes this happens quickly, sometimes it takes years of price growth lagging earnings growth. The manner cannot be predicted, but the near certainty that some of the overvaluation would eventually need to be burned off was within the realm of foreseeability.
And boy, did it burn off. The past twelve months have seen the intersection of a 26% price drop mix with 16% earnings growth. At $2.16 per share, the current price of $50 per share brings the valuation down to the much more reasonable 23x earnings. Given that Nike earns the majority of its revenues outside the United States, its earnings are impaired by the strong dollar. On a constant currency basis, the valuation is about 20.5x earnings.
If you are going to take a cue about Nike’s business, I would pay a lot more attention to the 13% dividend hike announced last month rather than the 26% price decline that Nike has endured in the past year. The price decline was warranted because Nike’s valuation was re-enacting the Dotcom Era last year.
It is an act of in-real-time irrationality that, even on an as-stated basis, Nike’s valuation is competitive with that of the S&P 500 as a whole. Nike offers somewhere between double and triple the long-term earnings growth of the index, and yet, each dollar of profit from Nike is being valued at the same rate as the valuation of America, Inc. that we call the S&P 500 Index. I have no idea what tomorrow’s earnings will bring, but the shareholders that pay $50 or lower for their ownership position in Nike are nearly certain to not only beat the S&P 500 over the next decade, but amass total wealth that is quite extreme to what the index investors will reap.