With its stock down 11% over the past three months, it is easy to disregard NIKE (NYSE:NKE). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on NIKE’s Return on Equity (ROE), an important factor to be considered by a shareholder.
What is ROE?
Return on equity or ROE is a measure of how effectively a company is using its shareholders’ equity to generate profits. It reveals the company’s success at turning shareholder investments into profits. In other words, it measures how much profit a company generates from each dollar invested by its shareholders.
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
Based on this formula, the ROE for NIKE is:
35% = US$4.9b ÷ US$14b (Based on the trailing twelve months to November 2024)
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?
ROE is a measure of a company’s profitability. Depending on how much of these profits the company reinvests or ‘retains’, and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don’t have the same features.
NIKE’s Earnings Growth And 35% ROE
To begin with, NIKE has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 13%, the company’s ROE is quite impressive. This likely paved the way for the modest 7.6% net income growth seen by NIKE over the past five years.
Comparison With Industry Average
As a next step, we compared NIKE’s net income growth with the industry and were disappointed to see that the company’s growth is lower than the industry average growth of 22% in the same period.
NYSE:NKE Past Earnings Growth
| Year | Net Income Growth |
| — | — |
| 2020 | 10.1% |
| 2021 | 7.2% |
| 2022 | 6.5% |
| 2023 | 8.1% |
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock’s future looks promising or ominous.
Is NIKE Fairly Valued?
These 3 valuation measures might help you decide:
- Price-to-Earnings (P/E) Ratio
- Dividend Yield
- Price-to-Book (P/B) Ratio
NIKE Valuation Measures
| Measure | Value |
| — | — |
| P/E Ratio | 24.5x |
| Dividend Yield | 1.2% |
| P/B Ratio | 6.4x |
Is NIKE Using Its Retained Earnings Effectively?
NIKE has a three-year median payout ratio of 39%, which implies that it retains the remaining 61% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.
Story Continues
Besides, NIKE has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts’ consensus data, we found that the company’s future payout ratio is expected to rise to 47% over the next three years. Still, forecasts suggest that NIKE’s future ROE will rise to 48%, even though the company’s payout ratio is expected to rise.
Summary
On the whole, we feel that NIKE’s performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. However, the company’s net income growth is lower than the industry average, which might be a concern for investors.
Conclusion
NIKE’s 35% Return on Equity is impressive and suggests that the company is using its shareholders’ equity effectively. However, the company’s net income growth is lower than the industry average, which might be a concern for investors. It is essential to consider other valuation measures and factors before making an investment decision.
Disclaimer
This article is not intended to provide financial advice or recommendations. The information provided is for educational purposes only. Always do your own research and consult with a financial advisor before making any investment decisions.
