sportswear giant Nike (NKE 5.96%) had a difficult year; the comma is one of the worst performing members of the Dow Jones in 2022, and the stock has fallen further after reporting earnings for the first quarter of its fiscal year 2023. It’s understandable to see stocks selling off in this market, but why did Nike stumble so much?
Knowing the answer to this question can help you answer another: Is Nike worth buying? Or should you run away as fast as you can? A look at the numbers will highlight some short-term challenges, but you might be surprised at the long-term outlook. It’s time to dive.
Nike ran too far, too fast
Nike doesn’t need an elaborate introduction: the company is the world’s leading sportswear brand; iconic sound comma is everywhere, endorsed by many of the world’s greatest athletes, from Michael Jordan to LeBron James and Cristiano Ronaldo. He is also well known to investors as not only one of 30 members of the Dow Jones Industrial Average but an all-time title winner. A $10,000 investment in the company’s IPO (Initial Public Offering) would be worth $7.6 million today, even after the stock’s big drop.
But picking the right stock is only part of the investment return equation; the price you pay also plays a huge role. The market was very lively at the start of 2021 on the heels of stimulus funds pouring into the market. You can see below how Nike price/earnings ratio (P/E) climbed to over 80:
That’s well above what Nike has historically bargained for; its median 10-year P/E is just over 28. The stock market tends to weigh stocks based on their long-term fundamentals, so if a stock’s valuation goes way above or below its long-term standards, there’s a good chance she’ll eventually come back. As you can see above, most of Nike’s slippage this year negated the extreme overvaluation from 2020 to 2021.
Recognize short-term problems
It can take an event to trigger the reversal of a stock, like what you see with Nike. It could be a general market downturn, and you’ve seen that too. But Nike has also had some company-specific issues lately. For starters, inflation hurts Nike’s profit margins. Gross margin decreased by 220 basis points in the first quarter of fiscal 2023 due to higher transportation costs.
Additionally, retail stores that buy Nike products and resell them to consumers are sitting on tons of inventory. Management explained on the earnings call how supply chain challenges made it difficult to predict when orders would be filled, so retailers ordered a bunch of product, taking the more cautious approach than sorry. Consumer spending was strong and retailers did not want empty shelf space. But now that inventories are back, consumer spending is falling as the economic outlook becomes increasingly fragile.
Instead of slowly and painfully managing off-schedule inventory, management is ripping the band-aid off and aggressively discounting to clean it up and wipe the slate clean as supply chain conditions return to normal. Management has warned that margins will be hit this year, but it will allow the business to return to normal sooner.
Take the chance
It’s important to distinguish between the broader appeal of the Nike brand and a short-term hiccup with its inventory. There doesn’t seem to be any evidence that Nike tarnished its brand. Sometimes unusual circumstances occur and a business has to make tough decisions to repair the damage. I think it’s safe to say that the past few years have been anything but ordinary.
Analysts expect a big hit to bottom line this year. Earnings per share (EPS) for fiscal 2023 could drop to $3.60, down slightly from the $3.75 posted for fiscal 2022. However, analysts still expect annual EPS growth of 12% over the three to five next few years, underscoring the belief that these inventory problems are temporary.
Nike has grown EPS by 11% per year on average over the past decade, meaning growth could pick up slightly even with a disappointing 2023. The stock is already trading 14% below its median P/E ratio, so long-term investors are looking for a solid buying opportunity today. It doesn’t matter if Nike sells even more; the company’s long-term prospects appear intact, making it a compelling investment idea for savvy and patient investors.