Nike is one of the most highly regarded growth stocks. Of course, there's plenty of reason for this. Nike shares are up 188% in the past five years, which is almost double the return for the S&P 500 Index in the same time period. However, whether Nike is as good of an investment opportunity today as it was then, is much less certain.
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Nike has grown revenue and earnings for those several years, but its valuation has also expanded considerably. As you can see, Nike's P/E multiple is very near a 10-year high.
Meanwhile, as Nike's stock price roared higher, its dividend yield shrank to just 1%, which represents a 10-year low. This is because dividend yields and stock prices are inversely related.
At this point, while Nike is a great business and a strong brand, it's not a great stock to buy, because it doesn't offer much in the way of margin of safety. For that reason, I'd urge investors to take a look at Foot Locker instead of Nike.
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Nike: Not much room for error
Nike is a very successful company. Last year, revenue and earnings per share from continuing operations rose 10% and 11%, respectively, from 2013. Over the first three quarters of the current fiscal year, revenue and diluted EPS are up 13% and 19%, respectively, excluding foreign exchange effects.
Those are certainly strong numbers, and it's clear that Nike is a highly profitable company that generates strong cash flow. Whether those numbers justify Nike's lofty valuation isn't as clear. At its recent closing price of approximately $105 per share, Nike trades for 30 times trailing earnings. That is well above the S&P 500's earnings multiple of around 20, which means Nike is about 50% more expensive than the stock market as a whole.
Such a high valuation implies a very high level of investor expectations. This has provided investors with very strong gains up to this point, but those gains might not continue if Nike's growth levels off. Add to this the fact that Nike's dividends aren't providing much of a boost, and there's an argument to be made that investors buying Nike at these levels are taking on a significant amount of risk going forward.
A safer play
If Nike's high valuation and low dividend yield concern you, I'd suggest Foot Locker as a suitable alternative. That's because Foot Locker is much less aggressively valued than Nike, and offers a higher dividend yield (1.7% at recent prices). Foot Locker trades for 17 times trailing earnings, which is significantly cheaper than the broader market. It's cheap, but also offers growth.
Foot Locker grew revenue and earnings per share by 10% and 25%, respectively, last year. Foot Locker is a growth company itself. And, after last quarter's earnings, Foot Locker raised its dividend by 14% and approved a new three-year, $1 billion share buyback program, to help keep earnings growth intact. This was a 67% increase from the company's previous share buyback plan. Foot Locker also offers a 1.7% dividend yield. While 70 basis points might not seem like a big spread, put differently, Foot Locker pays investors 70% more income than Nike, for every dollar invested.
Plus, owning shares of Foot Locker actually gives investors back-door exposure to Nike. According to Foot Locker's most recent 10-K filing with the SEC, the company purchased 73% of its merchandise from Nike last year.
Forget Nike, go for Foot Locker
Foot Locker's more conservative multiple and higher dividend yield provide more margins of safety than Nike, in the event that not everything goes according to expectations in future quarters. Nike is a great business, but investors may be getting too enthusiastic right now. Take a pass on Nike, and buy Foot Locker instead.
The article Forget Nike, Here's a Better Stock to Buy 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.
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