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Nike - Running a Bit Ahead of Fair Value
Posted by: Dr. Paul Price (IP Logged)
Date: September 14, 2012 04:54PM
It’s easy to claim to be a long-term investor. Looking backwards at a chart like Nike (NKE)'s makes it appear that nobody would have been tempted to sell shares in a company that posted higher EPS in every one of its fiscal years since 1998.
The reality for most humans would have been much tougher. Why was that? Changing economic conditions superimposed upon wild swings in market psychology pushed NKE’s shares from reasonable valuations to overpriced ones. NKE even occasionally hit bargain basement levels.
Most traders don’t really understand what a business is worth. They base buy and sell decisions on technical factors like moving averages and share price momentum. Many people use ‘stop loss’ orders that, ironically, often lock in losses rather than avoid them.
Notice that NKE shares peaked at $46.20 (split-adjusted) and at 23.7x earnings in late 2004. 18-months later NKE shares were $37.79 simply because the multiple had contracted to 14.4x even as the EPS had grown. Many disappointed traders were long gone as they concluded they had ‘made a mistake,’ based on the theory that ‘the market is never wrong.’
Nike proceeded to surge by almost 87% through early 2008. This occurred as earnings grew and the P/E expanded. People holding NKE felt wonderful. They were once again sitting on nice gains and great momentum. Rather than selling at that high point they waited for what they hoped would be even bigger profits.
Instead, the crash of 2008-09 took NKE back to $38.20. That was a level well below its year-end 2004 quote. At that point, those who had held NKE for more than four years were sitting on negative total returns. Experiences like that are why you often hear phrases like “buy and hold is dead” from whipsawed traders.
Even many previously die-hard NKE supporters threw in the towel. Unfortunately for them it was at what turned out to be, the best entry point based on valuation, in more than 14 years. At the March 2009 nadir NKE was offered at 11 times trailing EPS with a 2.4% dividend.
From such a favorable valuation NKE began a three-year uptrend. Nike generated a 200% gain before topping out earlier this year. I’m proud to say I wrote up NKE on February 10, 2009 on Seeking Alpha with NKE at $47.77 just a few weeks before the exact bottom.
Why is it so hard for most investors to figure out what to do with high-quality stocks? You get simultaneously conflicting advice from various, credible, sources like Value Line, Morningstar and Standard and Poors. What’s more surprising is that many of these sources give conflicting advice within their own reports. Here are some examples.
Morningstar’s neutral ranking (3-stars out of 5) and ‘fair value’ of $100 does not make sense to me with NKE shares already at $100.59 and yielding only 1.44%. Why would you want to hold a stock that is already trading for slightly above what you think it is worth?
Here’s a real mind bender…
Standard and Poors assigned Nike a 4-Star BUY rating with the shares at $99.29. They carry a 12-month target price of $100 – just 0.7% above its current quote. S&P goes on to say they feel fair value is $85.60 or 13.8% below the current price. On the next line they indicate that NKE has an ‘Investability Quotient’ in the top 1% of all stocks in their research universe.
Can any readers please explain to me why this merits a BUY rating based on what S&P has published?
Next up? Value Line’s research opinions. In their latest full page coverage NKE was trading down at $92.96 after reporting a rare year-over-year quarterly decline in the May quarter.
Value Line slapped Nike with SELL ratings of 4 for ‘timeliness’ and ‘technical’ on a scale of 1 = best, 5 = worst. NKE’s bad momentum (the drop from $114.81 to $92.96) led VL them to warn people away from new commitments. Only after the shares had rebounded to above $97 did Value Line decide to upgrade their opinions to neutral for both timeliness and technical.
Why quibble about missing a paltry 5% move?
Nike’s 10-year median multiple has been 17.0x. Their average yield from 2002 to 2011 was 1.36%. If NKE regresses to a typical P/E of 17 on the FY 2013 estimate of $5.13 it would sell for about $87.21 by next May. A return to their normalized yield of 1.36% would allow for a current price of $105.88. Splitting the difference of those two metrics leads to a fair value of about $96.50 in my book.
Unless you’re much more bullish than analyst expectations, NKE is a tad pricey right now. There are better bargains to be had. If NKE pulls back towards $80 - $90 I’d be thinking about recommitting to this very fine company.
Don’t let research firms snow you with irrelevant or conflicting information. Use the KISS (Keep It Simple Stupid) system. Buy individual stocks when they trade for below their historical valuation norms. Sell when they get more than a little above their typical valuations.
Lather, rinse, repeat.
Disclosure: No position
Stocks Discussed: NKE,