Should Investors Sprint to Buy or Stand Pat?

Last night on CNBC’s Mad Money, Jim Cramer said he sees accelerating earnings growth from shoe companies and Nike (NKE) in particular. Nike has lagged the performance of Deckers (DECK) and Sketchers USA (SKX) by a very wide margin, which could be a buying opportunity according to Cramer because Nike is best of breed. Cramer sees the bull market in shoes to continue and cites rising sales from shoe retailers, although they are not the best way to play the trend.

“But we want to own best of breed, right? Best of breed in the area that has the most exposure to this bull…the companies that actually make the shoes. Remember DSW wasn’t so hot. Finish Line wasn’t so hot. Foot Locker was not so hot. See, we need the ones that are hitting it out of the park. Companies like Nike and Deckers, Skechers and Madden. I’ve already gotten behind Deckers, the makers of Uggs and Skechers, two stocks that have already given us impressive gains. I’m not disavowing them. Uh-uh. No way. But right now you want to own the best of breed; the best of the best. And there’s no doubt in my mind what that is, Nike…Nike is the global king of footwear with the most market share and huge opportunities in emerging markets. The company has a fabulous long-term story. It’s one of the most recognizable and beloved brands in the world…

Nike’s got the best geographic diversity of the four companies we’re looking at. Just 43% of its sales come from North America. 75% from Skechers, 89% for Deckers. 96% for Steve Madden. Plus, Nike hasn’t run as much as the others. It’s up just 55% in the last year. Versus 419% for Skechers. 172% for Deckers. And 154% for Steve Madden. Those are all good stocks. But Nike’s the only one that hasn’t traveled up to nosebleed heights. Now, Nike just reported a fabulous quarter last Wednesday. Earnings of $1.01 per share, beating the street’s consensus estimate by 12 cents. On sales up 6.6% the year over year. Now, I know other sales were up better…

As Goldman Sachs points out in a terrific Conviction Buy report, over the past decade Nike’s stock has seen not one but two periods of big gains that have lasted for multiple quarters. Both times those gains were driven by earnings acceleration. And that’s where Nike is again right now. Its earnings growth is picking up, after several quarters of flattish growth. And that’s where NIKE is again right now. Its earnings growth is picking up. After several quarters of flattish growth. As Nike’s earnings growth moves into the double digits, courtesy of recovering economies around the globe and the bull market in shoes…” — CNBC’s Mad Money 3/22/2010

Clearly, Cramer is bullish on shoe makers and later he continues to say that he is bullish on future quarterly sales of Nike as well thanks to the company’s own future sales estimates as well as a marked drop in inventory reported in their last quarter. In addition, the upcoming warm weather months will be full of sales catalysts for Nike including March Madness, the NBA Playoffs, Wimbledon, the Boston Marathon and the World Cup to name a few.

This evidence works to support Goldman’s research report claiming Nike could be coming back around on a traditional cycle where earnings start to accelerate after a period of slow growth. Yearly earnings dating back to 2008 have come in at $3.74, $3.81, and $3.82 (est.). However, analysts’ estimates are quickly rising after last quarter’s strong performance with 18 of 21 analysts tracked by Yahoo finance having raised estimates in the last 30 days, and the acceleration may be just beginning.

With that being said, we currently have a Fairly Valued rating on NKE as the valuation is actually approaching the upper end of its historically normal ranges. For example, over the last ten years (roughly the same time frame as the Goldman report) NKE has traded for a price-to-cash earnings multiple of 13.0x to 19.8x, but given the current fundamentals it trades near the upper end of the range at 19.3x. Furthermore, the current price-to-sales per share stands at 1.92x, which compares to the historically normal range of 1.35x to 2.04x. So, even if you incorporate current growth estimates for the next year, the company is far from undervalued. Nike is certainly seeing fundamentals improve, but according to our methodology much of that has already been priced-in. We think it is reasonable for Nike to trade for a premium to other shoe companies (as it does to Deckers and Madden) because of their global market share and their potential for growth, but an investor must realize the market is currently paying a comparatively high price to what it has historically paid.

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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