Nike has now shed 30% of its value in 2024. If you’d bought the world’s most famous sneaker company five years ago, you should’ve been on the right side of trends such as growth in e-commerce and the casualisation of the world during the pandemic. Instead, you would be down 10% on your position and dividends wouldn’t have saved you.
The p:e multiple at Nike was about 34 five years ago. It’s now crashed to 20 — an even lower level than we saw in March 2020, when the world went mad. Even though earnings are up over five years (admittedly not by much), the unwind in the valuation multiple has ruined returns.
It’s easy to point to the high earnings multiple at Nike and identify this as the problem, especially with the benefit of hindsight. The truth is more nuanced than that. A high multiple isn’t always a bad thing. The problems come in when the multiple isn’t grounded in earnings growth, but rather in “quality” metrics that aren’t always resilient. Eventually, disruption and competition come to us all.
Value investors wouldn’t have held any Nike shares, as they believe strongly in the importance of the safety net a modest multiple brings. They are generally a sceptical bunch, taking the view that great times for a company cannot continue forever. Instead of believing in economic miracles such as a lack of competition and endless expansion in operating margin, they look for solid businesses trading at low multiples.
The idea here is that the earnings yield (the inverse of the p:e multiple) should give you a solid return even if the company can just maintain its current level of profitability, let alone achieve any growth. Don’t confuse this with an approach of seeking out bargain basement rubbish, as many companies are cheap for a reason. These are called “value traps” and, as the name suggests, are a value investor’s kryptonite.
Conversely, growth investors are all about the bright lights and shooting stars, chasing companies that have exciting futures. They aren’t interested in “boring” industries and companies trending sideways. Most of all, they aren’t shy to pay for this privilege, as high-growth companies trade at demanding multiples. If the earnings grow substantially each year, the multiple is applied to an ever-increasing base and the share price returns are appealing.
With exposure to consumer discretionary spending and little in the way of a moat beyond the brand and its distribution, Nike isn’t a defensive stock
But here’s the thing: Nike isn’t a high-growth company. Earnings per share achieved a compound annual growth rate of less than 9% in the past decade, which is useful but not exciting. Instead, it’s been seen as a quality stock and a relatively safe choice for an investor. But with exposure to consumer discretionary spending and little in the way of a moat beyond the brand and its distribution, Nike isn’t a defensive stock. At such a high multiple, this made it vulnerable to internal and external pressures that could lead to a drop in financial performance, earning swift punishment from the market in the form of an unwind in the traded multiple.
Compare Nike and its unjustifiably high multiple to the equally high multiples we’ve seen in the technology industry, where we are seeing a growth rate unlike anything the world has seen before. Technology companies have astonishing distribution power, thanks to the internet and the strength of the typical software-as-a-service business model. They have excellent cash flow visibility and, for the best enterprise-focused firms (such as Microsoft), the products are so embedded in the day-to-day operations of customers that churn is negligible.
These are potent business models that deserve to trade at high multiples, especially as they are hitting another growth spurt thanks to the rapid adoption of AI. Nike can only dream of having a business model this powerful.
The problem at Nike wasn’t just the high multiple. It was the combination of high multiple and low growth, which meant the multiple was being justified by the market based on the defensiveness of Nike and its brand strength. Those are poor reasons to pay a high multiple and thus accept a low earnings yield. In a rare example of agreement between these schools of thought, both value and growth investors would’ve been inclined to avoid Nike.
Ultimately, regardless of what type of investor you are, it all comes down to the valuation multiple relative to the growth prospects. When the multiple looks weirdly high for a company with modest growth, just don’t do it.
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