Nike (NKE, Financial) stock has been underperforming for at least the past half-decade, with its price down 31% over the last twelve months and 21% over the past five years, at the time of writing. Before delving into the reasons for this poor performance, it's important to consider why investors would want to buy Nike stock and include it in their portfolio.
In my view, Nike is a "moat" company. It boasts a well-regarded brand that consistently generates consumer demand, and its management team has a history of executing effectively—even during challenging times (until now).
On its investor relations page, Nike describes itself as a "growth company" but also emphasizes its commitment to rewarding shareholders through dividends and buybacks. This combination has historically justified the company's high valuations, which, in my opinion, excludes Nike from being aligned with the value investing philosophy (companies trading at a significant discount to their intrinsic value.)
However, when the perception of growth is disrupted by challenging macroeconomic conditions and retail industry pressures with booming competition, and when dividends and buybacks aren't enough to sustain the premium on its stock, it leads to increased bearish sentiment in the market.
As a result, Nike seems to be caught in a limbo between growth, dividends, and value, a situation clearly reflected in the stock's performance in recent years. In this article, I will dive deeper into these factors and explain why I believe Nike could remain "dead money" for an extended period.
Understanding Nike's Decline
To understand why Nike, a company with such a powerful brand, has seen its stock price drop 60% from its peak in 2021, it is important to first review how the company arrived at this point.
At the time, back about three years ago, Nike's management justified its strong momentum by citing "brand strength, a culture of innovation, and a proven operational playbook." Following the recovery from the challenges of 2020—marked by the COVID-19 pandemic—Nike's top-line revenue grew by 19% in 2021 and an additional 4.8% in 2022. Net income rose significantly, from $2.54 billion in 2020 to $5.72 billion in 2021 and $6.04 billion in 2022. It is worth noting that Nike's price-to-earnings (P/E) ratio reached an all-time high of 84x in late November 2021.
However, this momentum has not been sustained over the last three years. While Nike's top-line revenue has shown a modest compound annual growth rate (CAGR) of 2.7%, the company's operating income has shrunk by 5.7%, undermining the notion of a strong growth potential and diminishing its perceived competitive edge.
Several factors have contributed to Nike's declining performance. One significant factor is the weak economic recovery in China, one of Nike's key markets. The recovery in China has been slower than expected, and with new political leadership advocating for tariffs on Chinese goods, along with retaliatory tariffs from China to the U.S., Nike's bottom line could face further strain.
In addition, the consumer environment in the U.S. has been under pressure due to inflation, and there has been a shift away from athleisure—the dominant trend during the COVID-19 pandemic—toward more traditional wear. For those still buying athleisure, Nike faces increased competition from emerging brands like Hoka and On (ONON, Financial), which have been gaining market share and creating additional competitive pressure.
In response to these challenges, Nike has appointed a new CEO. Elliott Hill, a long-time Nike executive, was recently named president and CEO. Hill's proven track record in driving innovation and improving team engagement is expected to bring a fresh perspective to the company. His leadership could help refocus Nike on key initiatives, which might positively impact both its culture and overall performance.
Why did Nike feel this was the right time for a leadership change? In fiscal year 2024, Nike's revenues showed minimal growth, increasing by just 1% in the fourth quarter. Specifically, revenues fell by 2% year-over-year in Q4. This was especially disappointing given that Nike typically enjoys annual growth of 7-9%, with 10% being considered a strong year. To grow just 1% was underwhelming, and a 2% decline in the fourth quarter, despite relatively strong global economic growth (excluding China), was seen as a significant setback.
Nike's management acknowledged these challenges, with the CEO stating, "we are taking our near-term challenges head-on, while making continued progress in the areas that matter most to NIKE's future - moving at the pace of the consumer and growing the complete marketplace". The CFO also remarked, “While we are encouraged by our progress, the fourth-quarter results highlight challenges that have led us to update our fiscal 2025 outlook.” By "update," they meant a downgrade, though the company refrained from using the term “downgrade.” In addition, Nike pulled its full-year guidance, which is atypical for a company of its stature, further spooking investors.
Given these challenges, it is understandable why the market has become increasingly cautious about Nike's future prospects.
What Is Nike Doing to Turn Things Around?
Nike has not been passive in the face of these challenges and has taken steps to improve its performance, even in the midst of a difficult market environment.
One key strategy the company has adopted is leveraging its strong gross margins, which have reached up to 45% in the last twelve months. The management team has focused on selling fewer units but at higher prices. By raising prices, Nike expects to increase its margins and, in turn, boost its profitability. Additionally, Nike has been reducing its inventory of popular products, such as Jordan, Air Force One, and Dunk, with inventories down by 50%. The goal here is to better manage stock levels and enhance profit margins—an approach that seems quite sensible given the circumstances.
However, the full impact of these initiatives may take time to materialize. According to analyst consensus, Nike is expected to report fiscal 2025 earnings per share (EPS) of $2.81, which would represent a 29% decline in its bottom line. Revenue for the year is projected to fall to $47.54 billion, a 7.5% decrease from the previous year. While analysts expect bottom-line growth to resume in fiscal 2026, it is anticipated to remain below 15% until at least fiscal 2029.
To offset some of the uncertainty around its stock performance, Nike has ramped up shareholder returns in an effort to regain investor confidence. The company has a strong history of increasing dividends, having raised them for 22 consecutive years, and it continues to do so. In the most recent quarter (Fiscal Q1), Nike returned $1.8 billion in dividends ($560 million of which was a 6% increase from the previous year), and repurchased $1.2 billion in shares as part of its four-year, $18 billion buyback program.
In total, for fiscal year 2024, Nike returned approximately $6.4 billion to shareholders, increasing its dividends by 8% compared to the prior year, and repurchasing 4.3 billion worth of shares. Currently, Nike offers a dividend yield of 1.98%, along with a buyback yield of 5.3%.
NKE Stock Valuation
The issue surrounding Nike's stock performance in recent years appears to be closely linked to its high valuations. After bottoming out in March 2020, Nike's next-year P/E ratio surged to as high as 80 times by late 2021, around the same time that most growth stocks peaked. Justifying such bullishness at those levels became increasingly difficult. Over the next few years, Nike's P/E ratio has dropped to below 20 times, a level seen more recently in mid-2023.
Taking a closer look at the table below considering the company' direct peers, we can see that Nike has lower gross margins and is the only company with projected shrinking revenues for the next year.
Source: Author, using Yahoo Finance and GuruFocus data.
In comparison, Adidas (ADDYY, Financial), despite having slightly better margins than Nike, has struggled with poor sales growth and a disastrous bottom line over the last three years, yet trades at similar cash flow multiples to Nike. Puma (PMMAF, Financial), while also having slightly higher margins, has demonstrated stronger revenue growth and trades at a significant discount relative to Nike.
A key concern for Nike is the strong market share gains of competitors like Lululemon (LULU, Financial), which has grown sales at a CAGR of 21.8% and profits at over 25% in the past three years, all while maintaining 58% gross margins. Worse still, Lululemon trades at only a small premium over Nike's cash flow multiple. Also noteworthy is the strong growth of On Holdings (ONON, Financial), which, despite trading at much higher multiples than Nike and its peers, has achieved a staggering sales CAGR of 48.6%, with gross profit margins exceeding 60%.
This comparison suggests that while legacy footwear brands have faced similar challenges, Nike's struggles with margins and growth—at least compared to its direct peers—are particularly concerning.
In Conclusion
Nike's stock has been underperforming due to a combination of factors, including a sluggish economic recovery in China, a shift in consumer preferences, and increased competition.
The company is trying to turn things around by raising prices and reducing inventory, but it remains to be seen whether these moves will pay off in the long run. Analyst expectations for Nike's future earnings and revenue are fairly low, and the company's high valuation compared to its peers raises some red flags.
With a lot riding on the company's next steps, Nike's stock seems like a bit of a dead money at this moment. Even though its valuations are the lowest they've been in the past three years, I still hesitate to invest in Nike based on its growth or value appeal. Additionally, I don't find it appealing enough to justify the risk of relying on dividends and buybacks as the primary investment thesis.
