Nike (NYSE:NKE) and Under Armour (NYSE:UAA) have similar business models, yet they are in different stages of the business life-cycle. Nike is the industry leader, but Under Armour is gaining popularity among consumers. Which one has the best long-term investment potential?

Market share
Companies with high market share like Nike have already done the hard work of winning over customers. Nike has ingrained its brand in consumers' minds with its iconic swoosh logo. Nike commands 60% of the US sneaker market, while Under Armour has a 2.25% share. In US athletic apparel, the market shares of Nike and Under Armour are 27% and 14.7%, respectively.  

Nike gets 55% of its revenue from outside of the US, versus 5.9% for Under Armour.  Under Armour has had trouble with gaining traction in foreign markets where brands such as Nike have stronger recognition. Opportunity exists for Under Armour here, but there's also great risk that the investments might not pay off. Under Armour may have its hands full with trying to gain share in the US and foreign markets at the same time. 

Cash earnings
Cash flow gives investors a better look at the operations of a company than just net income, which can be misleading. Companies that consistently generate free cash flow, or FCF, and reward shareholders with dividends, stock buybacks, or debt reduction warrant further review. Under Armour, unlike Nike, does not pay a dividend. Investors expect this because Under Armour is a much younger company and investing cash back into the business will hopefully pay off in higher operating cash flow.

FCF for:201120122013
Nike $1.4 billion $1.3 billion $2.4 billion
Under Armour -$41 million $149 million $32 million

Nike's FCF over the period has ballooned. The slight drop in 2012 stemmed from a large increase in accounts receivable and increased inventory numbers. Under Armour's FCF has been highly volatile, starting in negative territory and then increasing significantly before leveling off in 2013, and this mostly resulted from inventory troubles. Nike has used its FCF to increase its dividend in every year since 2009 and has bought back stock when appropriate.

Under Armour has used stock options for compensation, which has led to increased amounts of shares outstanding upon exercise. Usually companies offset this by buying back shares in the market to offset the dilution. Under Armour has not done so, which can be explained by its FCF generation. The volatility in operating cash flow shows Under Armour's lack of efficiency in running its operations. Since Under Armour is in the process of expanding its business globally, we can expect its capital expenditures to rise in the future. This will further strain FCF unless Under Armour increases operating cash flow more quickly. This has not been the case thus far--Under Armour's lofty share price has not been supported by FCF growth. 

Valuation metrics
One of the most popular valuation metrics is the price-to-earnings ratio.  Nike and Under Armour's P/E ratios come in at 26 and 77 times earnings, respectively. Compare this with the industry average P/E of 21.66 and the valuation of Under Armour should raise some eyebrows.  High multiples imply that investors will pay up for potentially higher earnings in the future. Companies with high multiples, like Under Armour, either need to grow into their multiples with increased earnings or see their share prices fall, which will bring their ratios back to more normal levels.

Both of these scenarios include a high level of risk. Investors should not look at earnings figures in isolation. The price-to-FCF ratio shows how much investors are willing to pay based on FCF. Nike and Under Armour's P/FCF multiples are 28 and 395, respectively. This further shows Under Armour's sky-high valuation when compared to Nike. Nike is a proven company that has a history of rewarding shareholders with dividends and buybacks, hence the lower multiple. Under Armour is a relatively new company with riskier cash flows and paying 395 times FCF seems unreasonable.

Foolish takeaway
Under Armour has a lot of room to grow its business in the coming years given its low market share percentage, but it can be seen as risky given its inconsistent FCF and lofty multiples. Nike is a proven company that pays you to wait with increased dividends and stock buybacks. In this case, Under Armour seems highly risky and investors should proceed with caution, while Nike should be looked at further as a potential long-term holding.