Take a quick glance at Nike’s (NYSE: NKE) share price history and it’s almost impossible not to be amazed by the sheer level of returns that have been generated over the past twenty years. It’s pretty much the perfect share price chart: something you would draw if you could map out your ideal long-term investment. A decade ago the shares were trading for a split adjusted share price of $10 a share. Today they are going for $55. When Peter Lynch was talking about ten-baggers hiding in plain sight it’s stocks like Nike that he had in mind: companies with high returns on capital operating in steady sectors. The fact that Nike has achieved the feat in a little over a decade – compounding at an annual rate of 16% since 2000 – is astonishing.
What I like best about the Nike story is that it is the building of global brand power, playing out in real time, in a “new” sector. Nearly all the stocks that have been covered so far on the site have multi-decade brand history behind them: Coca-Cola was a beverage leader before the Second World War, Hershey was making chocolate bars over a hundred years ago, Procter & Gamble’s Tide was a best seller in the late 1940’s and so on.
Nike, and sports apparel in general, is building huge brand equity in a relatively new area: sports commercialisation. It’s a sector that has sprung up due to huge advances in broadcast technology and the ever increasing amount of money that is generated by professional sports. The most recent international TV deal struck by the Premier League (England’s top football division), for example, was worth $4.8bn per year. In 1992 it was worth just $12m. The NFL commands TV revenue of over $7bn a year and is rising. In 2014 it was $6bn. Golf, basketball, tennis and a host of other global sports are all following the same trend of increasing commercial revenue.
It’s tempting to put Nike today in the same category as some of the companies above were in the 1980’s or early 1990’s. You essentially have a super high quality company, with an established global brand, that is able to grow revenue, net income and earnings per-share at a double digit clip. Outside of the tech sector there aren’t many $100bn companies that post that kind of record.
In the last decade an investor in Nike stock has seen dividend growth of 14% compounded per year. A $10,000 investment in 2006 would be worth $57,000 today, assuming all dividends received over the period were reinvested, and $52,800 if they had just been left to accumulate in a broker account. It’s an astonishing amount of wealth creation in such a short time frame. Even more so when you consider that the S&P 500 has returned you about $20,000 on the same starting capital.
Back in 2006 to get your hand on the stock you would have been paying about $16 for every $1 of actual Nike profit. That’s amazingly cheap for a high quality stock showing the kind of growth rates that Coca-Cola were in the 1970’s. Today it would cost you a little over $25 for the same dollar of underlying profit.
When I did a piece about Nike for Seeking Alpha back in January I commented that, at over 30x prior year earnings, you’d be better off waiting to buy it. A fair number of comments were critical of that approach, pretty much rubbishing it as market timing: “Nike is a stock where it’s always a good time to buy” was the gist of it. The thing is that when you consider the following points about the underlying business it seems like one of those stocks that you can buy any price, any time: average five year operating margins are 3x the industry average; average returns on equity are over 30%, again roughly 3x the industry average; and average returns on capital are now touching 30% – once again about 3x the industry average.
(Source: Nike 2016 Annual Report)
The differential in the above figures all come down to Nike’s huge brand equity and superior logistics operation. Open one of Nike’s annual or quarterly reports and you will find that they even account for this brand equity building in their cost of sales. It goes down as demand creation expense. It’s the marketing cost that goes specifically towards building and expanding the famous Nike brand. That means things like endorsements from top sports stars and teams, as well as advertising in sporting events like the FIFA World Cup.
In the depths of the bear market following the 2008 financial crisis you could pick up Nike for something like 11x prior year earnings. What you get with that is two points: firstly you get the incredible quality of the underlying business, its growth and the great chance of good long-term returns associated with it. The second point is that you get a high probability that those “organic” returns are turbo-charged by an expanding value multiple. Nike isn’t going to be trading at 11x prior year earnings for very long. You can be reasonably confident that a move to something like 15x earnings, or approaching the historical mean, is therefore going to add significantly to your total returns (and is totally unconnected to the underlying business).
Compare that to buying Nike at the start of this year, when you would have been paying over 30x last year’s profits. You still get your stake of incredibly high quality profits (and great growth), but what you miss is that second point above, which over the course of a long term investment can add up to huge amounts of “lost” wealth. The good thing is that with the current 2016 slide – the stock is actually 20% down since that article was published in January – you are into the long term investment zone. At that point you have an incredible brand showing the type of growth that hit dividend aristocrats like Coca-Cola in the second half of twentieth century, and the returns to go with it.