Over the past ten years, management bought back approximately $35 billion worth of shares at an average price-to-earnings ratio of around 35x. During this same period, the company's debt increased significantly, from roughly $8.8 billion to $23.7 billion, raising its debt-to-equity ratio from 0.7x to 1.7x.

First, let's consider when and why buybacks can enhance long-term shareholder value:

• Undervalued Stock Price

  • If management believes the stock is undervalued, buying back shares can effectively invest in the company at a discount.

  • Remaining shareholders benefit as each share represents a larger ownership stake.

• Excess Cash with No Better Alternatives

  • If the company generates more cash than can be profitably reinvested (e.g., no high-ROI projects, mergers or acquisitions aren't appealing, and debt reduction isn't needed), buybacks become an efficient method to return capital.

• Strong Balance Sheet

  • Buybacks should not jeopardize financial stability. Companies with low debt levels and stable cash flows can justify buybacks more easily.

• Tax Efficiency Compared to Dividends

  • In certain jurisdictions, capital gains (resulting from increased share prices due to buybacks) are taxed more favorably than dividends.

  • Thus, buybacks might appeal more to shareholders compared to increased dividends.

• Offsetting Dilution

  • Companies with significant stock-based compensation (common in tech firms) can use buybacks to offset dilution, maintaining or improving per-share metrics.

Given these criteria, do buybacks make sense for Nike?

Was Nike's stock price undervalued over the past decade?

A straightforward historical valuation based on the P/E ratio suggests no. Nike's average P/E ratio over the past 25 years was 25.87x, with a median of 21.36x. The average P/E ratio for the last ten years was significantly higher, at 35.04x, indicating overvaluation. Similar conclusions arise from other valuation metrics like price-to-cash-flow or enterprise value-to-EBIT. Thus, from a long-term investor’s perspective, buybacks transferred value from shareholders who did not sell to those who did.

Were there no better investment alternatives than repurchasing shares?

This question is harder to answer externally, as we lack visibility into specific potential investments Nike considered and rejected. However, we know Nike’s CapEx growth has stagnated around $1 billion, with an average growth rate of just 1%. Given that Adidas also experienced limited CapEx growth (around 3%), it's reasonable to assume Nike’s management was prudent in avoiding overinvestment.

Did share repurchases increase default risk or jeopardize financial health?

Although Nike's debt-to-equity ratio increased from 0.7x to 1.7x, the company's debt levels have remained comfortably aligned with earnings and assets, maintaining solid leverage ratios such as debt-to-EBITDA and interest coverage. This suggests Nike has not overleveraged relative to its cash-generation capacity. Provided Nike remains profitable and maintains strong cash flow, its share repurchase program does not appear to have significantly increased default risk or compromised its financial health.

Are capital gains (resulting from buybacks) taxed more favorably than dividends?

Having worked in tax consultancy and auditing for approximately one year, I recall that, for private individuals in Germany, dividends are taxed immediately at around 25% (plus surcharges). In contrast, share buybacks defer taxes until shares are actually sold, offering a timing advantage. For corporate or holding structures owning at least 10% of a company, both dividends and capital gains are typically 95% tax-exempt, minimizing the difference beyond timing. Below that threshold, the deferral benefit from buybacks is more pronounced. Thus, the tax advantage of buybacks over dividends is generally limited in Germany.

Did Nike’s repurchasing program offset dilution and help maintain or grow per-share metrics?

Nike’s stock-based compensation over the past decade amounted to around $4.4 billion, significantly less than the $35 billion spent on buybacks. Therefore, yes, Nike comfortably offset dilution caused by stock-based compensation.

In summary, Nike’s buyback program over the past decade has not materially weakened its balance sheet or excessively increased risk. However, from the perspective of a long-term investor who never sold shares, it's fair to question whether repurchasing shares at an average valuation of roughly 35x earnings represented the best possible use of capital. Ideally, companies repurchase shares when they are undervalued or at least fairly valued, and when no superior strategic investment opportunities exist.

Given Nike’s premium brand, robust cash flow, and solid growth prospects, the buybacks were not disastrous. However, the benefit to continuing shareholders is less compelling if, indeed, Nike consistently repurchased shares at valuations above their fundamental worth.

Yet realistically, I am only in my sixth semester studying economics and business administration - what insights could I possibly have that financial experts and advisors within and surrounding Nike have missed?

JJF