The stock market has been very volatile lately; stocks are soaring one day and plummeting the next. Overall, the broader market still seems in a downtrend, with recession fears running rampant across Wall Street.
Sporting apparel company Nike (NKE 0.66%) has held its own; shares are down just 10% over the past year. Investors can appreciate a quality company with decades of growth to its name. However, stocks can get too crowded.
Nike may be a proven winner, but that doesn't make it a buy today. Investors should consider some good and bad news before buying shares.
The good news: Nike's inventory problem seems temporary
Companies like Nike had a tough time navigating disrupted supply chains during the pandemic; management had to order products aggressively to ensure it had enough, which created a glut over 2022. Nike is correcting the issue, marking down excess inventory to sell, which has begun rightsizing at the expense of its gross profit margin:
NKE Inventories (Quarterly) data by YCharts
Nike reported strong revenue growth; sales in the quarter ended Feb. 28 were $12.4 billion, a 14% increase year over year. But gross margin slipped 330 basis points, trickling down to diluted earnings per share (EPS) that came in 9% lower year over year at $0.79.
Management noted on its recent earnings call that it had reduced inventory orders over the past six months, so retail partners should continue depleting inventory as needed. The stepping off the gas, so to speak, will impact revenue growth in the fourth quarter; management guided for flat to low single-digit sales growth next quarter. Investors will know more next quarter when management discusses fiscal 2024 guidance, but Nike's inventory problems are seemingly almost in the rearview mirror.
The bad news: Investor expectations remain high
Investors have given Nike the benefit of the doubt; shares are down just 10% over the past year, proving resilient in a market where many stocks have seen much worse. One can look at a stock's valuation as what Wall Street expects from a company; you'd pay a high valuation for a stock because you expect it will perform at a high level.
Nike has done that for the past decade, averaging annual EPS growth of more than 23%. That earned shares an average price-to-earnings ratio (P/E) of almost 37 during that time. The problem is that high expectations leave a long way to fall if unmet.
NKE PE Ratio data by YCharts
Analysts see Nike's earnings growth taking a step back, with consensus estimates calling for EPS growth to average 10% over the next three to five years. That's roughly the S&P 500's long-term average growth rate, and the index trades at a forward P/E of just 18.
The verdict: Is Nike a buy today?
That doesn't automatically mean that Nike will fall 50% to trade on par with the S&P 500, but it seems unlikely that the market will pay such a significant premium for the stock if growth falls off. Nike is a much larger company today; its market cap has more than tripled over the past decade. Eventually, it's just hard to keep growing an increasingly larger number at the same rate.
Nike is still a great company and one of the world's most recognizable brands, so it belongs in a long-term portfolio. However, if you're on the outside looking in, it may be wise to wait for a better opportunity to buy shares than what you're looking at today.
