Sports apparel giant Nike (NKE -0.36%) is an easy stock to like. Its "swoosh" is a global cultural icon and dominates the sporting landscape. The stock's also been one of the great investments of all time, up more than 130,000% since its 1980 Initial Public Offering, minting millionaires from modest investment sums.
The company's popularity has translated to its share price; Nike stock seems to rarely ever come cheap, which might make the stock a tempting buy on any pullback. Well, shares are down roughly 19% from all-time highs hit in November. But consider the following before you buy that dip.
Image source: Getty Images.
Nike's best growth days are likely over
Nike has grown into one of the world's largest companies; it's a member of the Dow Jones Industrial Average and has a massive $229 billion market cap. It's grown leaps and bounds since 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 over the course of the two-year-long COVID-19 pandemic. Revenue fell 38% year over year for its quarter ending May 31, 2020, when lockdowns peaked, keeping shoppers out of most stores. Nike snapped back a year later -- revenue for its quarter ending May 31, 2021, grew 96% compared to that soft 2020 quarter. This is beginning to balance out; revenue grew just 1% year over year in its most recent quarter, ending Nov. 30, 2021.
NKE Revenue (Quarterly YoY Growth) data by YCharts
If you zoom out from the pandemic volatility, Nike's revenue has grown an average of 7% per year over the past decade. Nike's adapted well to the pandemic, developing its e-commerce channel with higher profit margins. A higher number of direct-to-customer sales could help earnings growth over time as it cuts out the "middleman" retailer. Still, investors should probably expect Nike to hover in that high-single-digit revenue growth without a significant catalyst, which I don't see right now. The company's certainly not stale, but it seems like a stretch to call it a high-growth business.
The stock's valuation is creating returns
Nike's positive reputation might help explain the stock's steady rise over the years. The stock's become nearly twice as expensive since 2013 when its price-to-earnings (P/E) ratio was roughly 20. Today, Nike's P/E ratio hovers around 38. In other words, if the stock had maintained its valuation over the decade, it would be worth half as much today!
NKE PE Ratio data by YCharts
Sometimes a company does something to deserve a higher valuation, like growing revenue faster or changing the narrative around the stock. But when a stock's valuation increases for no good reason, it often reverts to its "normal" level at some point. So does Nike deserve to be twice as expensive as a decade ago?
I find it hard to make that case with certainty. Analysts are optimistic about revenue growth over the next couple of years. They're calling for 6% year-over-year growth for the current fiscal 2022 year, but expect 14% growth in 2023 and 10% in fiscal 2024. Nike's direct sales could continue growing, and the company's already brought its brand into the metaverse, which could eventually create potential new opportunities.
The biggest reason that Nike's growth could perk up is the eventual recovery from supply chain issues that are currently affecting Nike's manufacturing. Management has noted that these issues have affected Nike's operating results.
Reaching the finish line
Ultimately, there's still a lot to like in Nike, the company. But the stock doesn't seem to offer a margin of safety for investors, a "safety net" in our homework that helps account for things falling short of what we thought would happen.
It seems hard for investors to make a firm argument that Nike's revenue will grow 10% per year or more for the next decade. But if the stock did revert to a lower valuation, its average P/E over the past decade is 27, meaning a 25% drop in share price to get on par with it.
Because of that, it seems like there's more potential for downside than upside. Investors may want to wait for a steeper correction in the market to bring shares further down. Yes, the stock has gotten cheaper than its highs, but it seems like it needs to keep cooling off before it'll make sense again to buy shares.
