Nike's Dividend Yield Surges to a Record 4.8%. Is the Dow Component the Ultimate Turnaround Dividend Stock or a Yield Trap?

On Oct. 2, Nike (NYSE: NKE) plummeted to a 13-year intraday low of $31.97 per share before recovering to $33.87 by the end of the session.

The sell-off was in response to Nike's first quarter fiscal 2027 earnings and guidance, which forecasts a high single-digit decline in fiscal 2027 revenue.

Nike's tumbling stock price -- paired with 24 consecutive years of dividend increases -- has pushed its dividend yield up to 4.8% -- making it the highest yielding component in the Dow Jones Industrial Average (DJINDICES: ^DJI).

Here's why Nike's turnaround has gone from bad to worse, why Nike's problems are far from over, if its dividend is affordable or poised for a cut, and if Nike is a high-yield dividend stock to buy in October.

Image source: Nike.

Double-digit revenue declines in Jordan and Sportswear

Nike hit an all-time high in 2021 as customers shifted their shopping from in-store to online. It was a boon for Nike, as direct-to-consumer can translate to higher margins by cutting out wholesalers and providing a more data-driven connection with customers, which can help tailor promotional campaigns to their interests and improve new product development.

The sales boom was so large and sudden that Nike wrongly assumed it was a permanent shift in buyer behavior. Nike's results since the pandemic have made it painfully obvious that it remains heavily reliant on its wholesale partners -- such as Dick's Sporting Goods (which also owns Foot Locker).

In addition to Nike's supply chain challenges, it has also been overly reliant on key brands like Jordan to drive sales. Jordan has been Nike's ace in the hole for decades. But in its latest quarter, Jordan brand revenue fell by mid-teens, which is significant given it accounted for 13% of global sales. Nike Sportswear, which makes up just under half of Nike's Q1 fiscal 2027 revenue, also saw low double-digit declines.

Aside from its self-inflicted challenges, Nike has also been dealing with inflationary pressures, pullbacks in consumer spending, and a widespread slowdown in China -- a key market for Nike. The slowdown has gone from bad to worse, with China revenue falling 26% in Q1.

Nike's dividend is evaporating its free cash flow

In Nike's defense, some of the revenue declines are on purpose. The consumer discretionary company fell into the bad habit of overproducing products, which led to bloated inventories and deep discounts-- crushing margins. Now, it is focused on fewer releases and stores, a shift toward premium brand presentation.

Nike's turnaround has been prolonged because the extent of companywide challenges, the damage to its supply chain, and the dilution of its brand have been more severe than many investors expected. At least now, management is addressing it openly rather than sugarcoating the issues. The good news is that bringing issues to light is exactly the type of transparency that investors want. But the relentless selling pressure on Nike's stock price reflects how patience has run out for many investors.

The silver lining is that a smaller, leaner Nike should lead to higher margins and a more sustainable path toward earnings growth. The bad news is that in the meantime, the strategic shifts are taking a sledgehammer to Nike's profitability. Cash dividends and capital expenditures continue to outpace operating cash flow -- which is unsustainable.

NKE Free Cash Flow Per Share data by YCharts

As you can see in the chart, Nike's dividends paid over the trailing 12 months exceeded its free cash flow (FCF) per share, and its elevated payout ratio is a red flag. If these levels persist, Nike may be pressured to cut its dividend. But if Nike's drastic strategic changes do begin to improve margins and FCF, it may not need to make a dividend cut. On its Q1 earnings call, management said the dividend remains a significant priority in Nike's capital allocation strategy, so it's doubtful Nike would cut it unless the situation worsened.

It's also important to note that Nike's balance sheet remains in excellent shape. It exited Q1 with $6.9 billion in cash and cash equivalents compared to $2 billion in its current portion of long-term debt and $5.89 billion in other long-term debt.

Nike's turnaround remains messy

Investors shouldn't expect Nike's turnaround to be nearing an end anytime soon. Major changes to the business, paired with ongoing external challenges, indicate a difficult operating environment.

The best turnaround companies aren't the ones that keep their dividends intact at the expense of much-needed cash, but rather, the ones that make drastic improvements to their operations -- which can lead to lasting improvements. This is exactly what Domino's Pizza did in the 2010s when it fundamentally changed its recipes and embraced mobile ordering and delivery tracking.

Nike has the global brand recognition needed to stage an epic recovery, and its dividend appears safe for now. But some investors may want to see more measurable signs that the underlying business is improving before diving headfirst into the stock.

Daniel Foelber has positions in Nike. The Motley Fool has positions in and recommends Domino's Pizza and Nike. The Motley Fool has a disclosure policy.