As an investor, it can be tempting to dismiss NIKE (NYSE:NKE) with its stock down 11% over the past three months. However, we believe that long-term financial performance is often a better indicator of a company’s potential than short-term fluctuations in stock price.
In this article, we will focus on one important metric: Return on Equity (ROE). We’ll explore how ROE is calculated, what it means for earnings growth, and why NIKE’s high ROE is promising. We’ll also examine the company’s dividend policy and future outlook.
How Is ROE Calculated?
The formula for calculating ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
Using this formula, we can calculate NIKE’s ROE as follows:
ROE = US$4.9b ÷ US$14b (Based on the trailing twelve months to November 2024)
ROE = 35%
This means that for every $1 worth of shareholders’ equity, the company generated $0.35 in profit.
What Has ROE Got To Do With Earnings Growth?
As a measure of profitability, ROE is an essential factor to consider when evaluating a company’s potential for growth. Companies with high ROE and strong profit retention tend to have higher earnings growth rates compared to those with lower ROE and weaker profit retention.
NIKE’s Earnings Growth And 35% ROE
NIKE has a high ROE of 35%, which is significantly higher than the industry average of 13%. This suggests that the company is reinvesting its profits effectively, resulting in a strong growth rate. Over the past five years, NIKE’s net income grew by 7.6%, which is modest compared to the industry average growth of 22% during the same period.
Is NIKE Fairly Valued Compared To Other Companies?
When evaluating the stock price, it’s essential to consider whether the expected growth or decline in earnings is priced in. We’ve compiled three valuation measures that may help you decide if NIKE is fairly valued:
- Price-to-Earnings (P/E) Ratio: This ratio compares the company’s current share price to its earnings per share (EPS).
- Price-to-Book (P/B) Ratio: This ratio compares the company’s market capitalization to its book value.
- Dividend Yield: This is the ratio of the annual dividend payment to the stock’s current price.
These metrics can help you determine whether NIKE’s stock price is reasonable compared to other companies in the industry.
Is NIKE Using Its Retained Earnings Effectively?
NIKE has a median payout ratio of 39% over the past three years, indicating that it retains around 61% of its profits. This suggests that management is reinvesting earnings efficiently and paying out a decent dividend to shareholders. Furthermore, NIKE has been paying dividends for at least ten years or more, demonstrating its commitment to sharing profits with investors.
Future Outlook
Analysts’ consensus data predicts that NIKE’s future payout ratio will rise to 47% over the next three years. However, forecasts suggest that the company’s ROE will increase to 48%, indicating potential for continued growth. We assume that this growth is driven by other characteristics of the business rather than a change in dividend policy.
Conclusion
In conclusion, NIKE’s performance has been impressive, with high ROE and strong profit retention leading to modest earnings growth. While industry analyst forecasts indicate slower earnings growth ahead, we believe that NIKE remains an attractive investment opportunity.