What Keeps Me From Buying Nike Stock

By Markets Fool.com

Nike is one of the most well-known growth stocks around. There's good reason for this: Owning Nike stock has been a highly rewarding proposition.

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NKE Chart

NKE stock price data by YCharts.

As you can see, Nike has richly rewarded its shareholders for many years. And yet, I don't have much desire to add Nike to my portfolio because it doesn't offer a strong dividend. Here's what Nike could do to entice a much larger group of investors to buy the stock.

Nike gives dividends the cold shoulder
Nike is technically a dividend stock, in that it pays a dividend. But the dividend yield is just 1%. That's about half the yield of the S&P 500 Index, and is about 90 basis points below the 10-year U.S. Treasury Bond. Nike's dividend yield doesn't even keep pace with inflation. The point is, dividend investors probably aren't too tempted to buy Nike stock.

It's not uncommon for companies to offer low yields if they are more concerned with reinvesting profits back into the business to generate future earnings growth. But typically, investors get a trade-off. In exchange for a low yield now, many of these stocks grow their dividends at high rates over time. This makes their paltry current yields more acceptable.

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Nike is a high-dividend-growth stock. During the past five years, it's raised its dividend by 15% compounded annually, which is an excellent growth rate. The problem is that it will take a very long time for Nike's dividend yield to reach a significant level, even with strong dividend growth each year. For example, even if Nike continues to increase its payout by 15% per year, it would take a decade for the stock to provide a 4% yield.

Because of this, it's likely that income investors aren't buying Nike. And before you think stronger dividend growth might not be feasible for Nike, think again.

Buybacks get all the attention
It's likely Nike doesn't increase its dividend to a higher level because it doesn't have the cash flow -- but not for the reason you might expect. Nike could easily double its dividend, or even go above that, if it didn't spend so much cash on share repurchases.

Nike's capital allocation program is heavily skewed, perhaps overly so, toward share buybacks. In the first three quarters of its current fiscal year, Nike generated $2.6 billion of free cash flow. In this time, the company used just $658 million, or approximately 25%, of its free cash flow on dividends.

Instead, Nike prefers to utilize its free cash flow to buy back its own stock. It spent almost three times as much on buybacks than on dividends during the first three quarters of the year. Last quarter alone, Nike spent $612 million to repurchase 6.5 million shares as part of the company's ongoing four-year, $8 billion share-buyback authorization. Nike is $5.3 billion into its repurchase program.

Share repurchases can serve a valuable purpose when employed at the right time. Buying back its own stock when it's cheap can be a shrewd financial management strategy for a company to significantly increase earnings per share. But the key part of this is for companies to conduct the buybacks when their stock is cheap -- which Nike is not. The stock trades for 29 times earnings, which is very close to its 10-year high of 30 times earnings.NKE PE Ratio (TTM) Chart

NKE P/E Ratio (TTM) data by YCharts.

At such a lofty valuation, Nike's share repurchases may not be the best use of capital. Nike is highly profitable and generates a lot of cash. It could easily increase its dividend by 50% or more, and only need to taper off its share repurchase program slightly.

If Nike were to take dividends more seriously, it could entice a whole new group of investors to own the stock. Perhaps it's time to give dividends a chance.

The article What Keeps Me From Buying Nike Stock originally appeared on Fool.com.

Bob Ciura owns shares of Apple. The Motley Fool recommends Apple and Nike. The Motley Fool owns shares of Apple and Nike. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.