Is Nike Stock a Buy After Catching a Breath?

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sportswear giant Nike (NYSE: NKE) is an easy-to-love stock. His “swoosh” is a global cultural icon and dominates the sporting landscape. The stock has also been one of the great investments of all time, rising more than 130,000% since its IPO in 1980, hitting millionaires from modest investment sums.

The company’s popularity was reflected in its share price; Nike shares rarely look cheap, which could make them a tempting buy on a downturn. Well, stocks are down about 19% from all-time highs reached in November. But consider the following before buying this dip.

Image source: Getty Images.

Nike’s best growing days are probably over

Nike has become one of the biggest companies in the world; he is a member of the Dow Jones Industrial Average and has a massive market cap of $229 billion. It grew by leaps and bounds from the early days, signing Michael Jordan in the early 1980s; it now sponsors dozens of the world’s greatest athletes and has generated $46 billion in revenue over the past 12 months.

Its revenue growth has been volatile during the two-year COVID-19 pandemic. Revenue fell 38% year-over-year for its quarter ending May 31, 2020, when closings peaked, preventing shoppers from accessing most stores. Nike rebounded a year later — revenue in its quarter ending May 31, 2021 was up 96% from that soft 2020 quarter. It’s starting to balance out; revenue grew only 1% year-over-year in its most recent quarter, ending Nov. 30, 2021.

Chart showing Nike's revenue declining in 2020, followed by an increase in 2021.

NKE revenue (quarter-on-year growth) data by YCharts

If you step away from the volatility of the pandemic, Nike’s revenue has grown an average of 7% per year over the past decade. Nike has adapted well to the pandemic, expanding its e-commerce channel with higher profit margins. A higher number of direct-to-customer sales could contribute to profit growth over time, as it eliminates the “middleman” retailer. Still, investors should probably expect Nike to hover in that mid-single-digit revenue growth without a significant catalyst, which I don’t see at the moment. The company is certainly not stale, but calling it a high-growth company seems like a stretch.

Stock Valuation Creates Returns

Nike’s positive reputation could help explain the stock’s steady rise over the years. The stock has become almost twice as expensive since 2013, when its price-to-earnings (P/E) ratio was around 20. Today, Nike’s P/E ratio hovers around 38. In other In other words, if the share had maintained its valuation over the decade, it would be worth half as much today!

Chart showing Nike's PE ratio increase since 2018.

NKE PE report data by YCharts

Sometimes a company does something to earn a higher valuation, like growing revenue faster or changing the narrative around the stock. But when a stock’s valuation rises for no good reason, it often returns to its “normal” level at some point. So does Nike deserve to be twice as expensive as ten years ago?

I find it difficult to make this case with certainty. Analysts are optimistic about revenue growth over the next two years. They forecast 6% year-over-year growth for the current fiscal year 2022, but expect 14% growth in 2023 and 10% in fiscal 2024. Direct Sales from Nike could continue to grow, and the company has already introduced its brand to the metaverse, which could eventually create new potential opportunities.

The main reason Nike’s growth could accelerate is the potential resumption of supply chain issues currently plaguing Nike’s manufacturing. Management noted that these issues have affected Nike’s operating results.

Reach the finish line

Ultimately, there’s still a lot to like about Nike, the company. But the stock doesn’t seem to provide a margin of safety for investors, a “safety net” in our homework that helps factor in things below what we thought would happen.

It seems difficult for investors to argue that Nike’s revenue will grow by 10% per year or more over the next decade. But if the stock returns to a lower valuation, its average P/E over the past decade is 27, which means a 25% drop in the stock price to match it.

Because of this, there seems to be more downside potential than upside. Investors may want to wait for a more pronounced market correction to drive stocks further lower. Yes, the stock has become cheaper than its highs, but it looks like it needs to continue to cool before it makes sense to buy stocks again.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end consulting service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.

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