Some people think investing is dry and boring.
I don’t agree.
I think investing is incredibly rewarding and exciting.
It’s also deceptively interactive.
What I mean by that is, it’s easy to invest in the products and/or services you personally use on a regular basis.
What could be more enjoyable than to personally profit from that which you already use and spend money on?
It’s especially awesome when it comes in the form of cold, hard cash!
This happens when you employ the dividend growth investing strategy, which funnels one right into high-quality businesses that pay shareholders safe, growing dividends.
To see examples of such businesses, take a look at the Dividend Champions, Contenders, and Challengers list – a compilation of hundreds of US-listed stocks that have raised dividends each year for at least the last five consecutive years.
I’d be willing to bet that you’ll spot many of the familiar names behind the products and/or services you regularly use.
By the way, they became so familiar because they’re great companies that are able to produce ever-higher profits (which are necessary to fund those ever-larger dividends).
This reward system – getting paid to use what you already use – has been super helpful to me as I’ve gone about building my FIRE Fund.
That’s my real-money portfolio, and it generates five-figure passive dividend income – often from the same companies that provide me with that which I already use and find value in anyway.
This passive income is actually enough for me to live off of, and it’s been enough to do so ever since I quit my job and retired in my early 30s.
Investing in the same companies that sell you what you use is a simple way to build wealth over time – while getting paid ever-larger cash dividends along the way.
However, it’s not quite as simple as that.
There’s also the matter of valuation.
Price is only what you pay, but value is what you get.
An undervalued dividend growth stock should provide a higher yield, greater long-term total return potential, and reduced risk.
This is relative to what the same stock might otherwise provide if it were fairly valued or overvalued.
Price and yield are inversely correlated. All else equal, a lower price will result in a higher yield.
That higher yield correlates to greater long-term total return potential.
This is because total return is simply the total income earned from an investment – capital gain plus investment income – over a period of time.
Prospective investment income is boosted by the higher yield.
But capital gain is also given a possible boost via the “upside” between a lower price paid and higher estimated intrinsic value.
And that’s on top of whatever capital gain would ordinarily come about as a quality company naturally becomes worth more over time.
Undervaluation introduces a margin of safety.
This is a “buffer” that protects the investor against unforeseen issues that could detrimentally lessen a company’s fair value.
It’s protection against the possible downside.
Buying high-quality undervalued dividend growth stocks that represent equity in the companies whose products and/or services you personally use is a rewarding and reinforced way to build wealth and passive income over the long run.
Of course, all of this does assume that one already understand the concept of valuation.
If you don’t yet have that understanding in place, Lesson 11: Valuation will help.
Written by fellow contributor Dave Van Knapp, it lays out valuation in simple-to-understand terminology and even provides a valuation template that you can apply to just about any dividend growth stock you’ll run across.
With all of this in mind, let’s take a look at a high-quality dividend growth stock that appears to be undervalued right now…
Nike Inc. (NKE) is an American athletic footwear and apparel corporation.
Founded in 1964, Nike is now a $116 billion (by market cap) sportswear leader that employs nearly 80,000 people.
FY 2024 sales can be broken down geographically as follows: 43%, North America; 28%, EMEA; 15%, Greater China; and 14%, APLA.
This is the world’s largest seller of athletic footwear and apparel.
Products are sold online, through third-party retailers, and through company-branded stores.
The company’s core Nike brand is the most popular athletic footwear and apparel brand in the world, estimated as having twice as much global sport footwear market share (~16%) as its nearest competitor (per Euromonitor).
Through innovation, investment, and strategic partnerships/sponsorships, the company has created an unrivaled “brand halo” around Nike, with this brand enjoying distinctive consumer awareness and cachet.
In addition, Nike sells products via the well-known Jordan brand, which is incredibly successful in is own right.
Now, recent results have been challenged by a post-pandemic normalization of sales, some self-inflicted wounds regarding retail relationships, and new competitors.
However, Nike remains the 800-pound gorilla of its industry.
And it remains poised to continue posting up solid revenue, profit, and dividend growth for years to come.
Dividend Growth, Growth Rate, Payout Ratio and Yield
Already, the company has increased its dividend for 22 consecutive years.
This company is approaching Dividend Aristocrat status.
Its 10-year dividend growth rate is 11.9%, which is pretty strong, although more recent dividend raises have been in a high-single-digit (8% or so) range.
Still, even high-single-digit dividend growth is enough to make sense of this idea, as the stock yields 2.2%.
This yield is unusually high, and I think the market has already adjusted the yield quite a bit higher in order to compensate for the moderate slowing in dividend growth.
Changes have been discounted, although Nike being able to get back to its prior ways could offer some nice upside.
With a payout ratio of 49.4%, which almost perfectly balances rewarding shareholders against retaining capital for the business, the dividend is clearly healthy.
Nike is clearly committed to its dividend and the growth of it.
It’s a healthy dividend growing a nice clip, and the yield isn’t bad at all.
I see a lot to like here.
Revenue and Earnings Growth
As much as there is to like, though, many of these dividend metrics are based on what’s happened in the past.
However, investors must always be thinking about the future, as the capital of today gets risked for the rewards of tomorrow.
Thus, I’ll now build out a forward-looking growth trajectory for the business, which will be of aid when the time comes to estimate fair value.
I’ll first show you what the business has done over the last decade in terms of its top-line and bottom-line growth.
And I’ll then reveal a professional prognostication for near-term profit growth.
Blending the proven past with a future forecast in this way should give us enough information to establish where the business might be going from here.
Nike advanced its revenue from $30.6 billion in FY 2015 to $51.4 billion in FY 2024.
That’s a compound annual growth rate of 5.9%.
Solid.
I usually look for mid-single-digit (or better) top-line growth from a mature business (and Nike is definitely mature), and Nike delivered.
Meanwhile, earnings per share increased from $1.85 to $3.73 over this period, which is a CAGR of 8.1%.
Very good.
While I think some investors might expect even more out of Nike, 8%+ bottom-line growth is still a great result.
That’s in the realm of world-class businesses.
However, much of this was front-loaded growth, occurring before and around the pandemic.
Nike experienced a demand boom between 2019 and 2022, and the company is dealing with a normalization hangover now.
Furthermore, Nike’s prior CEO (during that time), John Donahoe, who came to Nike with no real sneaker knowledge or retail experience, made a number of mistakes, including failure to nurture the brand and changing the distribution model that negatively affected relationships with longstanding retail partners.
On top of this, competitors (such as Hoka from Deckers Outdoor Corp. (DECK)) have recently come on even stronger and been trying to eat Nike’s lunch.
On the flip side, if Nike can do 8%+ growth in the face of all of that, it stands to reason that it could do even better with better operational focus.
Looking forward, CFRA currently does not have a three-year forecast for Nike’s EPS growth.
That’s unfortunate, as I do like to compare the proven past with a future forecast.
Again, I’d just circle back around to the fact that 8%+ was achieved with both competitive pressures rising and self-inflicted wounds.
Regarding the latter being fixed, Nike replaced Donahoe with former insider Elliott Hill, who was with the company for more than 30 years before temporarily retiring, in 2024.
Hill has a depth of experience around sneakers, retail, and Nike operations that Donahoe lacked.
This is largely a self-help story, in my view, and Hill seems like a smart choice to execute and play that story out.
Hill can do much to repair Nike, including repairing valuable relationships with retailers (Donahoe aggressively tried to cut retailers out and go heavy into DTC, which opened up retail opportunities for the very competitors that are now trying to take share from Nike), investing more into R&D/product, cutting wasteful costs, and being more involved in key sports relationships.
These are all important touch points, and each one can really move the needle.
This is still a terrific business with a best-in-class brand, and shoring up that brand will almost certainly be Hill’s chief concern over the coming years.
Nike doesn’t need to reinvent the wheel; it needs to get back to basics, crank up the awareness, and repair relationships.
None of this is all that difficult.
Providing further encouragement to shareholders should be the fact that Phil Knight, who co-founded the company, still owns more than 15% of Nike, and Knight is likely keen to see Hill make improvements and Nike thrive once again.
I don’t see why the next decade can’t be even better than the last, especially considering the starting point (EPS has been flattish for several years because of the issues I just laid out).
There’s no front-loading of growth to deal with now.
If anything, there could be a coiled spring in place here, which would spell great results once the fixes are implemented.
That said, erring on the side of caution, I’d still take the last decade’s results as a good base case for the next decade.
And that would line investors up for something like 8% annual dividend growth.
Combining that with the 2%+ starting yield gets one to a 10% or so annualized total return, and that’s before assuming any rerating on the stock (which would likely come as improvements are made) or better growth (which would also likely come as improvements are made).
It’s hard to see how one does poorly with the shares, and yet the upside could be big.
Looks like a nice setup to me.
Financial Position
Moving over to the balance sheet, the company has a stellar financial position.
The long-term debt/equity ratio is 0.5, while the interest coverage ratio is over 33.
As solid as these metrics are, they belie Nike’s true financial strength by ignoring the cash position.
Cash exceeds long-term debt, which means Nike is sitting on net cash.
This gives Hill and his team lots of flexibility in regard to reinvesting back into the business and executing on the turnaround.
Profitability is great.
Return on equity has averaged 40.5% over the last five years, while net margin has averaged 10.7%.
Notably, ROE is so high in spite of the low leverage.
Also, ROIC is routinely north of 20%.
This is a very profitable enterprise generating high returns on capital.
With a new CEO in place, an easy self-help story underway, and low expectations being placed upon it, it’s hard to not be enthusiastic about Nike over the coming years.
And with economies of scale, R&D, IP, unparalleled brand power, entrenched market share, and established relationships with retailers globally, the company does benefit from durable competitive advantages.
Of course, there are risks to consider.
Regulation, litigation, and competition are omnipresent risks in every industry.
Competition, in particular, is a major risk here, as the industry is fiercely competitive and only becoming more so.
The company’s aggressive DTC moves (in order to go straight to the customer and improve margins) have hurt relationships with retailers, caused inventory dislocations, and opened up opportunities for competitors.
Innovation has suffered of late, and the brand is arguably less strong than it used to be.
A global footprint is an advantage, but this exposes the company to geopolitics and currency exchange rates.
The very business model is exposed to changing trends in fashion, which can be fleeting and difficult to find persistent success in.
Nike gets 15% of its revenue from China, which is a mercurial market full of idiosyncratic challenges.
Visibility and relevance are of paramount importance to the firm, which will require more R&D and partnership spending, along with the right sponsorship deals at the right times.
I certainly see some risks present.
But a lot of risks have been priced in, as the valuation is baking in expectations about as low as they’ve been in a decade…
Valuation
The P/E ratio is 22.4.
For a world-class, industry-leading business, that is not egregious at all.
For perspective, this is far below its own five-year average P/E ratio of 34.1.
This gap shows you just how far Nike’s stock has fallen, and it illustrates how low the expectations have become now.
The stock used to command healthy premiums; it’s now available at a discount.
And the yield, as noted earlier, is significantly higher than its own recent historical average.
So the stock looks cheap when looking at basic valuation metrics. But how cheap might it be? What would a rational estimate of intrinsic value look like?
I valued shares using a dividend discount model analysis.
I factored in a 10% discount rate and a long-term dividend growth rate of 8%.
This dividend growth rate is at the top end of what I allow for, typically reserved for the best businesses out there.
While some shine has come off of Nike (it’s not quite as illustrious as it used to be), I think it’s clear that 8% growth is not a high hurdle to clear.
Recent dividend raises have been in this range.
And the last decade, which included the pandemic and some serious missteps by the former CEO, still allowed for an 8%+ EPS CAGR.
Starting from a low base and with a new CEO, I would be very surprised to see Nike do worse than that from here.
With the payout ratio so balanced, Nike could easily grow the dividend in line with (and, perhaps, even slightly faster than) EPS growth.
The DDM analysis gives me a fair value of $86.40.
The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide.
The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth.
It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today.
I find it to be a fairly accurate way to value dividend growth stocks.
Whereas this stock used to be too expensive, I think it’s now become too cheap.
But we’ll now compare that valuation with where two professional stock analysis firms have come out at.
This adds balance, depth, and perspective to our conclusion.
Morningstar, a leading and well-respected stock analysis firm, rates stocks on a 5-star system.
1 star would mean a stock is substantially overvalued; 5 stars would mean a stock is substantially undervalued. 3 stars would indicate roughly fair value.
Morningstar rates NKE as a 5-star stock, with a fair value estimate of $112.00.
CFRA is another professional analysis firm, and I like to compare my valuation opinion to theirs to see if I’m out of line.
They similarly rate stocks on a 1-5 star scale, with 1 star meaning a stock is a strong sell and 5 stars meaning a stock is a strong buy. 3 stars is a hold.
CFRA rates NKE as a 3-star “HOLD”, with a 12-month target price of $80.00.
A bit of a range, and it looks like I came out roughly in the middle. Averaging the three numbers out gives us a final valuation of $92.80, which would indicate the stock is possibly 22% undervalued.
-Jason Fieber
Note from D&I: How safe is NKE’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 99. Dividend Safety Scores range from 0 to 100. A score of 50 is average, 75 or higher is excellent, and 25 or lower is weak. With this in mind, NKE’s dividend appears Very Safe with a very unlikely risk of being cut. Learn more about Dividend Safety Scores here.
P.S. If you’d like access to my entire six-figure dividend growth stock portfolio, as well as stock trades I make with my own money, I’ve made all of that available exclusively through Patreon.
Disclosure: I’m long NKE.