Nike Is Expensive But Can Provide Substantial Income

Summary

• Nike stock is expensive (grade F for value from Seeking Alpha).
• The stock price is 31% above its pre-COVID 2020 high.
• Wall Street analysts are bullish.
• The option-implied outlook is bearish.
• A covered call strategy provides an attractive income level.

Nike (NYSE:NKE) has recently been ranked as the most valuable apparel brand in the world and the fortieth most valuable global brand across all industries. Given its enormous reach, it will not be surprising that Nike stock has had a stellar decade, with 20.73% annualized returns over the past ten years. NKE’s current stock price ($137.02) is 31% above its pre-COVID 2020 high of $104.53 (closing price on January 17, 2020). The stock is currently 6.8% below its 52-week high of $147.05 on January 11^th, 2021.

Trailing total returns for NKE, the footwear sector, and the U.S. equity market (Source: Morningstar)

With TTM P/E of 78.6 and forward P/E of 46.3, the stock looks expensive (Seeking Alpha’s Factor Grade for value is an F). Certainly these types of P/Es are high for the market as a whole and are even high compared to major technology stocks. Apple’s (AAPL) forward P/E is 29.1, Alphabet’s (GOOG) (GOOGL) is 30.1, and Facebook’s (FB) is 23.8. On the other hand, Nike is a marketing machine like no other and has revolutionized the athletic footwear, accessories, and apparel industry. It is hard to predict what kinds of earnings growth are possible for this company. In addition, Nike is expanding into the digital space, so a valuation like a tech firm is perhaps not unreasonable.

Wall Street Analyst Outlook

Even at the current high valuation, the consensus of Wall Street analysts is bullish, with a consensus twelve-month price target of $163.52 (calculated from ranked analysts by eTrade). This price implies a gain of 19.3% over the next year. Even the lowest price target from amongst the analysts is slightly above the current price. In other words, not one of the thirty ranked analysts that eTrade surveyed thinks that the current price is too high.

Wall Street analyst consensus rating and twelve-month price target (Source: eTrade)

Seeking Alpha’s calculation of a consensus view of Wall Street analysts results in an almost identical price target to that calculated by eTrade. Of the thirty three analysts in Seeking Alpha’s survey, eighteen are very bullish and ten are bullish. Only one is bearish and none are very bearish.

Wall Street consensus rating and price target for NKE (Source: Seeking Alpha)

Outlook from the Options Market

Another way to generate an outlook for a stock is to analyze the prices at which options on the stock are trading. The market prices of options provide information about traders’ consensus outlook on the probability of the price going above a certain level (call options) or below a certain level (put options) over some period of time (from today until the expiration date of the options).

By aggregating market prices of call and put options with the same expiration date but different payouts (different strike prices), it is possible to employ a mathematical model to calculate the implied probability of all possible future returns. This strategy is well-established in institutional finance. For some background, see the Minneapolis Fed’s web pages on their implementation. For a review of the literature on how options prices are useful in generating outlooks in general and with examples using my version of this approach, see this presentation.

The option-implied probabilities of expected price returns are charted as a probability distribution. When I chart the option-implied probability distribution for future return, I rotate the negative side of the distribution about the vertical axis so that the relative probabilities of positive and negative returns are easier to see.

The price outlooks derived from options prices are probabilistic rather than a specific forecast of the future price. The options prices may indicate increased or decreased likelihood of gains or losses and this provides insight into the prevailing beliefs of those buying and selling options.

I have analyzed options on NKE expiring on January 21, 2022, to generate the option-implied price return outlook from now until that date.

Option-implied price return probabilities for NKE to January 21, 2022

The option-implied outlook is moderately bearish, with a single most-probable price return between now and January 21, 2022 of -10.6%. The probabilities of negative returns are consistently (albeit modestly) higher than the probabilities of positive returns of the same magnitude (the red dashed line is above the solid blue line for all but the most extreme returns).

One interesting result from analyzing the options on NKE is that there are covered call strategies that look very attractive. You can sell a covered call on NKE with a strike price of $150 and expiring on Jan 21, 2022, for $11.50 (the current bid price). The $11.50 option premium equates to 8.4% yield ($11.50 / $137) for 10.7 months. In addition to that guaranteed income, you retain the potential appreciation from the current price of $137 to the strike price of $150, up to a 9.5% gain.

If the stock goes up 19%, as the Wall Street analysts predict, this covered call strategy provides a total return of 17.9% (8.4% option income yield plus 9.5% in price appreciation). The covered call strategy has sacrificed very little upside in this situation. If, on the other hand, the stock price declines by 10% (which the option-implied price return outlook suggests is not unlikely), you are only down 1.6% thanks to the option premium income. In addition to the option income yield, of course, the stock has a dividend yield of 0.8%.

Summary

Nike has revolutionized its industry and created one of the best-known consumer brands in the world. The market has recognized Nike’s achievements by bidding the stock up to valuations that are more typical of fast-growing tech firms. The challenge for investors today is whether there is additional upside to be had. The Wall Street consensus view is that the stock is likely to gain around 20% over the next twelve months. The option-implied price return outlook is moderately bearish.

Particularly given the current rich valuation, my overall rating is neutral as a compromise between the bullish analyst consensus and the bearish options market consensus. A covered call strategy with a high enough strike price to retain some price appreciation potential looks like an attractive compromise.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in NKE over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

If I go long NKE, I will also be selling a covered call as outlined here.