For Nike Stock, Bull Case Rests On One Key Question

In this bear market, there are a number of well-known stocks that have posted stunning declines. The plunge in Nike (NYSE:NKE) is among the most surprising.

On Nov. 5, NKE stock closed at an all-time high just shy of $176. In less than 11 months, the stock has fallen 53%, wiping out more than $140 billion of its market capitalization.

Source: Investing.com

That said, while the size of the plunge is surprising, the fact that Nike stock has struggled is not. The entire market is down: the S&P 500 index, of which Nike is a member, has declined 24% since Nov. 5.

Meanwhile, the inventory challenges that marked Nike’s disappointing fiscal first quarter are hardly unique to the company. Even the nation’s best retailers, including Walmart (NYSE:WMT) and Target (NYSE:TGT), have seen apparel inventory pile up this year. After binging on goods in 2020 and 2021, consumers worldwide in 2022 are spending their cash outside the home.

Those consumer trends led companies like Nike to stellar earnings in the post-pandemic environment. The bill for that performance now has come due.

But, taking the long view, NKE at these levels does look attractive for investors with one simple belief: Nike remains the same innovative, market-leading juggernaut it was before the pandemic. That seems likely to be the case, and it’s enough to at least give a long thought to owning NKE after Friday’s plunge.

The Valuation Concern

As we’ve talked about several times, the fact that a stock is down substantially does not make it a buy. This market, in which so many stocks have dropped 50% and then another 50% (or more), has taught that painful lesson to many investors.

And it’s worth noting that, even down 50%, NKE stock on its face does not look that cheap. Shares still trade at about 23x trailing 12-month earnings. And those last four quarters include the end of calendar 2021, when consumer spending on goods was still roaring.

Given that earnings declined 20% year-over-year in Q1, and that the 44% increase in Nike inventory suggests a few quarters of margin-reducing clearance ahead, the numbers for fiscal 2023 may be worse. It’s certainly possible that investors getting NKE “cheap” after this decline still are paying something like 25x this year’s profits, if not more, in the process.

That’s a decent multiple, admittedly. In fact, it’s about in line with where NKE traded in 2016 and 2017. But it’s not necessarily a multiple that suggests NKE is absurdly cheap. Rather, fundamentally it seems like investors might have been too optimistic a year ago, rather than being too pessimistic now.

The Case For NKE Stock

But looking a bit closer, there is a solid case for owning NKE stock here. The market actually repriced NKE stock before the pandemic. At the beginning of 2020, NKE traded for some 35x trailing 12-month earnings. Investors were bullish on the company’s innovation and the potential for its direct-to-consumer business.

Taking the long view, there’s a simple question to ask: Why doesn’t that same bull case hold now? Yes, Nike is dealing with short-term challenges. But, at least per management, its innovation remains on point: on the first quarter earnings call, executives waxed poetic about the “futuristic” Forward material, as well as a number of different footwear products. The DTC business grew nicely during the pandemic, and long-term Nike will keep at least some of the customers acquired.

Competition remains in the rearview mirror. Adidas (OTC:ADDYY)) stock is at a six-year low, and Under Armour (NYSE:UAA) is at its lowest point since 2011. As a business, Nike looks much the same as it did three years ago, albeit with a couple of potentially difficult quarters ahead.

Taking The Long View

To be sure, one thing certainly has changed: interest rates. That change in turn affects the valuation calculus around a stock like NKE. In 2019, investors were willing to pay more for the safety of Nike earnings at a time when U.S. government bonds offered a lower return than they do now.

But, again, relative to earnings (whether looking backward or forward, even assuming Wall Street estimates for this year come down) NKE stock is cheaper. In fact, it’s cheaper on an absolute basis as well: shares are down 18% since the beginning of 2020. Both factors to some extent price in the end of the so-called TINA (There Is No Alternative) environment for U.S. equities.

Personally, it would be nice to see Nike stock get even cheaper. In this market, it’s certainly possible. Still, there is a reasonable case for investors who still believe this is one of the world’s great businesses. After all, that’s what the market as a whole believed just a few short years ago. If and when that confidence returns, Nike stock should get back to its old ways.

Disclaimer: As of this writing, Vince Martin has no positions in any securities mentioned.