Nike: Good Company vs.Good Investment

NEW YORK (F.A.S.T. Graphs) -- Recently, I happened upon an excerpt of TheStreet.com founder Jim Cramer's CNBC show "Mad Money." Specifically, I'm referencing the "Lightning Round" segment on Aug. 26.

The first question was about Nike ( NKE), to which Cramer replied: "I like Nike. I like Under Armour even better."

Now, the second bit about Under Armour ( UA) might very well be true, but I'd like to investigate the Nike comment a touch more. I'm guessing Cramer and I share a similar view on this subject, but I also believe that it's important to decipher the difference between a good company and a good investment.

Just because someone says they like or don't like something doesn't mean that you can substitute that for proper due diligence. It's always good to double-check what you're hearing. Even within this article, there are many more items that you would probably want to investigate.

The first thing that I would check when looking into Nike is the company's business results.

One of the easiest -- and, in my view, most efficient -- ways to do is by utilizing the fundamental analyzer software tool of F.A.S.T. Graphs. Here we see that Nike was able to grow earnings by about 13% a year (orange line). In addition, we can also see that dividends (pink line and blue shaded area) have begun to increase at a steady rate.

In turn, shareholdings were rewarded for holding a good company whose business performed well. Total shareholder returns compounded at an annual rate of almost 14%, trouncing the S&P 500 during the same period and basically mirroring Nike's business results.

Further, it's really not much of a secret why NKE was able to provide such steady business results. If we take a look at the Fundamental Underlying Numbers (FUN) Graphs, we see that Nike has had steady gross profit margins along with net profit margins. People are consistently willing to pay a premium for having a swoosh embroidered on their apparel versus sporting a "non-check mark" alternative. Additionally, it should be noted that the consistency of margins is perhaps more relevant than their growth. Growing margins would be great, but once a company is churning out profits, sustainability is paramount.

In tandem, this translates to strong returns on investors' money. For example, return on equity has been stable as of late hovering around 20% and return on assets has been around the 14% mark.

Aside from consistent margins and shareholder returns, Nike has also demonstrated a propensity to sell more items and build up the value of the company. Specifically, sales per share and common equity per share have grown by a yearly average of about 9.7% and 10.8% respectively. Granted the latest recession created a small stutter-step, but for the most part NKE has done an excellent job of recovering. I suppose this isn't altogether surprising given that NKE does about 60% of its business outside of North America.

Finally, I'd like to note that while the business results of Nike have been steady to strong, management has also been active in efficiently reducing common shares outstanding via the company's share repurchase programs. This effectively boosts shareholder returns and makes it easier for the underlying business to achieve earnings per share growth.

So taking the metrics collectively -- strong operating results, increasing dividends, steady margins, reasonable returns on shareholder's money, consistent revenue growth and an effective repurchase plan -- it appears that Cramer is right on the money. In fact, after looking a bit deeper, I like the company quite a bit as well; it's easy to see why it consistently turns out profits.

Yet, liking the company and liking the shares of stock as an investment are two different things. If I looked at the company only, I would conclude that it is a very profitable and worthy partnership. However, we have not yet added value to the equation.

By adding the price (black line) and the normal P/E (blue line) to the first graph, we find that price and value can be two very different things. Here we see that the market has been willing to pay about 19.5 times earnings for shares of Nike in the past.

Given its premium performance, it seems reasonable that the shares would be priced in a similar fashion. However, today NKE stands at a P/E of 23; surely above its historical norm and the highest it has been since the "irrational exuberance" period of 1999.

To further envision the mismatch between a great company and a less-than-ideal valuation, the Estimated Earnings and Return Calculator provides five-year estimated total return results -- 4.8% -- that greatly trail the expected business results of the company.

Twenty-three analysts reporting to S&P come to a consensus estimated growth rate of about 13%. Looking to Zack's to test this number, one would find a similar projection. So the business results don't appear to be a problem, but the valuation moving forward might be. As a consequence, shareholder returns could lag business results even over the long term.

Now it is important to realize that the Estimated Earnings and Return Calculator is just that -- a calculator. As such, the total return estimate is based on consensus earnings estimates and growth rates, combined with an ending P/E ratio that is commensurate with the companies expected business results.

So, for example, if you believed that 19.5 was a more rational P/E number you could adjust the expected return upward. Although it should be noted that even then the performance returns would likely trail business results. In any event, it's important to stay humble in your assumptions.

As it stands, I believe that Nike provides a classic case of good company that might not necessarily be a good investment. As we have seen, there is a difference between finding the type of companies you want to partner with and buying them at a price point that will reflect business results or better over the long-term. Luckily, marginal investments can turn in to good investments courtesy of Mr. Market.

On the other hand, it's much more difficult for marginal businesses to turn into good investments. Today, Nike -- in my opinion -- certainly appears to be worthy of monitoring due to its strong business. But just because I like a company doesn't mean that I will simultaneously become an owner -- paying too much, even for quality, can lead the most astute investor astray.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

Charles (Chuck) C. Carnevale is the creator of FAST Graphs.

Chuck has over 43 years of financial experience and is the co-founder of the earnings and price correlated, powerful fundamentals analyzer software tool - FAST Graphs. Chuck holds a Bachelor of Science in Economics and Finance from the University of Tampa. Chuck's work stressing sound valuation has been widely published on numerous financial sites and blogs. Chuck is passionate about spreading the critical message of valuation and prudence in fundamental investing. So much so that regular readers have dubbed him "Mr. Valuation". Chuck is a Veteran of the Vietnam War and was awarded both the Bronze Star and the Vietnam Honor Medal.

Chuck believes that correctly assessing fair value is one of the primary keys of successful stock investing, and he has dedicated his more than 40 years of experience in finance to its pursuit. Chuck agrees with legendary investors such as Warren Buffett, who recognize how important it is for investors in common stocks to possess an intelligent framework for making sound decisions that can keep emotions out of the equation. With making smart stock selections, there is no room for fear and greed.

Chuck was fortunate to learn at an early age that earnings drive long-term stock prices, and that dividends, if any, will be paid out of a company's earnings. This led him to develop FAST Graphs, the fundamentals analyzer software tool that reveals the long-term relationship between a company's earnings and its stock price and dividends over time. Chuck is most interested in the business behind the stock.

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