My Favorite Stock Right Now

This stock was the worst performer in the Dow Jones Industrial Average in 2016. It came into 2016 with a streak of posting stock market gains for seven years. However in 2016, the stock declined by about 20% while the Dow Jones Industrial Average marched ahead by 13% in 2016.

What stock I am talking about? Nike Inc.

Even with the large decline in 2016, a long-term Nike investor has still come out way ahead. For example, if you had invested $10,000 in Nike on December 31, 1997 and had reinvested dividends along the way, you would have an ending investment value of $140,572! This is a total return of 1,307% or 15% annualized! If you had invested the same amount of money in Dow Jones Industrial Average, you would have just $37,617 for an annualized return of 7%. Nike crushed the Dow Jones Industrial Average during this period.

So why Nike now?

I bought shares around $50 in 2016 and wanted to do a write up on it last weekend but never got the chance. Since then the stock is up by 6% or so. I still think it is fairly valued or a little undervalued which is tough to find in the stock market right now.

So why the large decline in 2016? Well, the stock was valued in the 30 P/E range which is way too high – even for a company growing as fast as Nike is. Now the stock is trading in the 20 to 23 P/E range depending on which FY2017 earnings estimates you use. So the P/E compression was needed to bring it to a more reasonable valuation. I now believe Nike is trading at a reasonable valuation.

Nike is the most recognized global apparel brand in the world. It is the 29th top rated brand in the world with a AAA+ rating. The Nike Swoosh is associated with athletic success. I find it pretty easy to find someone wearing some kind of Nike gear anywhere I go, particularly in North America. Now it is becoming more common in Asia which should eventually become the largest consumer market in the world.

When you watch professional or college level sports such as football, basketball, baseball, hockey, golf, etc… you’ll see entire teams outfitted with Nike gear. Even some high school sports teams are outfitted with Nike. Top athletes around the world wear exclusively Nike gear such as Lebron James, Michael Jordan (Jordan brand with Nike), and Tiger Woods to name a few. This is brilliant marketing because when people (especially kids) see their favorite athletes wearing Nike, they want to wear the same stuff. This gets the Nike brand ingrained in them for life.

Nike is facing competition from upstart Under Armour which also produces a great product and is gaining ground in the athletic apparel department. However, Nike is still the clear front runner as it outfits the best teams and athletes. It will have to use its branding power and superior management to build on this lead.

Nike’s net profit margin averages around 10% for the past 10 years. The return on equity and return on capital average is in the low 20% range for the past 10 years. These are outstanding numbers considering how competitive the apparel industry is. This is a testament to the Nike brand and its management.

Over the last 10 years, Nike’s revenue has grown around 8% on an annualized basis while the earnings per share have grown around 13% on an annualized basis. Great numbers. I think you could probably see revenue growth in the 5-8% range going forward and earnings growth in the 10% range over the long-term. Earnings should grow faster than revenue because Nike will probably repurchase shares along the way and become more efficient, thus, expanding its profit margins.

Nike also maintains a pristine balance sheet with a debt/equity ratio below 0.2, a quick ratio above 1, and a current ratio above 2. This allows flexibility in the event of an economic downturn.

The one thing that might throw people off from investing in Nike is the low dividend yield. Currently 1.34%. But what people often don’t see is that the dividend payout ratio is below 30% and Nike’s dividend growth in the last five years has been around 15%! The earnings are projected to grow at least 10% each year. So Nike’s dividend has plenty of room to grow. Eventually, my investment in Nike will yield more than a 5% dividend payer such as AT&T because Nike’s dividend growth will crush AT&T’s over time. With AT&T, you’ll probably see a few percent of dividend growth each year but with Nike you should see double-digit dividend growth. This is an example of short-term pain for long-term gain. Then on top of Nike’s dividend growth, you’ll probably see significant gains in Nike’s share price as Nike increases its revenue and earnings faster than AT&T.

I think Nike has the potential to return >10% annually. This should be more than the Dow Jones Industrial Average and S&P 500 going forward based on current valuations.

Disclosure: I own Nike shares.

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