Nike (NKE -1.26%) has had a rough stretch. The sports-apparel company's stock has fallen 35% since January. The company's recent quarter for the period ended May 31 was a stark reminder of the current challenges facing retail companies.
There's no denying these short-term problems, but does that mean investors should run away? I don't think so. Nike's still a long-term winner worth buying, and I'll show you why below.
Why are investors spooked?
Nike's decline isn't all its fault. It's a member of the Dow Jones Industrial Average stock index, which holds just 30 stocks. The index is down 15% over the past year, which puts pressure on Nike stock, too. However, Nike's down much more than the index, indicating real challenges inside the business.
The company recently closed out its 2022 fiscal year, reporting earnings for the period ending May 31. Revenue was $12.2 billion for the quarter, down 1% year over year. However, inventory was up 23%. In other words, supply chain disruptions made it hard to bring products to shelves promptly. Management pointed to this in the earnings release.
High inventories increase the chances that Nike will have to discount products. That could mean pressure on profit margins over the coming quarters.
Focus on these two clues, instead
These problems are legitimate and worthy of investor attention. On the other hand, investors should ask themselves whether this is a fundamental problem with the business over the long term or just a temporary hiccup. Perhaps other clues from the earnings report point to Nike's long-term outlook remaining positive.
For example, the company has emphasized a direct-to-consumer sales strategy called Nike Direct, which brings higher profit margins because it doesn't need to sell at lower wholesale prices. While gross profit margins declined 80 basis points year over year in the quarter, full 2022 margins increased 120 basis points, primarily because of Nike Direct.
Nike's direct sales increased 7% yearly for the quarter and 14% for the entire 2022 fiscal year. Nike Direct is becoming a larger contributor.
Secondly, Nike's balance sheet remains very strong. It ended the quarter with $13 billion in cash against just $8.9 billion in debt. That's plenty of money to raise the dividend, which it's done for 20 consecutive years, and fund share repurchases. Nike's outstanding shares have declined 4% over the past five years.
Competitors can't match Nike's brand power
More importantly, Nike's brand recognition primarily drives its long-term success. Ultimately, Nike sells shoes and apparel, products with endless amounts of competition.
But Nike has proven repeatedly over the years that it's able to market better than anybody because the stars in the sports world keep gravitating to the brand. Years ago, it was Michael Jordan, but Nike has a massive stable of sports stars signed up to endorsement contracts.
These sponsorships span virtually every sport, from Cristiano Ronaldo in soccer to Lebron James in basketball. Sports fans will see the swoosh on most of their favorite athletes.
This recognition is why Nike can attract shoppers to its direct retail channel instead of relying solely on placement in traditional stores.
This plunge is a gift
Nike's been an immensely successful investment over its history, and it's a stock that typically commands a premium valuation. It can spend years at a time trading at high prices.
Investors should welcome the recent share-drop because Nike's finally reasonably valued again. The current price-to-earnings ratio (P/E) is 27, on par with the stock's median P/E over the past 10 years of 28.
NKE PE Ratio data by YCharts.
Meanwhile, the analyst community agrees that Nike's supply chain headaches are temporary. On average, they expect Nike's earnings-per-share (EPS) will grow by an average of 13% annually over the next three to five years, right on target with the company's 12% rate from the past decade.
Of course, Nike shares could continue falling, especially if the Dow Jones begins to slide like the Nasdaq, which is down 23% over the past year. But Nike is a proven long-term winner trading at a fair valuation, making it a stock worth considering in today's volatile market.
