Apparel Retail company Gap, Inc. is standing out today, surging to $9.71 and marking a 5.1% change. In comparison the S&P 500 moved only 0.2%. GPS currently sits within range of its analyst target price of $9.65, which implies that its price may remain stable for the near future. Indeed, the average analayst rating for the stock is hold. Over the last year, Gap, Inc. (The) has underperfomed the S&P 500 by 47.1%, moving -60.2%.
The Gap, Inc. operates as an apparel retail company. The company is a consumer cyclical company that markets discretionary goods and services, which are non essential items that consumers purchase with their discretionary income. For this reason, consumer cyclical companies have better sales -- and oftentimes stock -- performance during periods of economic growth, when consumers have more of an incentive to spend their money on non essential items. Conversely, performance can drop off significantly during periods of recession or economic contraction. This is why these companies are called "cyclical."
Gap does not release its trailing 12 month P/E ratio since its earnings per share of $-0.19 are negative over the last year. But we can calculate it ourselves, which gives us a trailing P/E ratio for GPS of -50.6. Based on the company's positive earnings guidance of $0.71, the stock has a forward P/E ratio of 13.7.
As of the third quarter of 2022, the average Price to Earnings (P/E) ratio for US consumer cyclical companies is 24.11, and the S&P 500 has an average of 15.97. The P/E ratio consists in the stock's share price divided by its earnings per share (Eps), representing how much investors are willing to spend for each dollar of the company's earnings. Earnings are the company's revenues minus the cost of goods sold, overhead, and taxes.
The problem with P/E ratios is that they don't take into account the growth of earnings. This means that a company with a higher than average P/E ratio may still be undervalued if it has extremely high projected earnings growth. Conversely, a company with a low P/E ratio may not present a good value proposition if its projected earnings are stagnant.
When we divide Gap's P/E ratio by its projected 5 year earnings growth rate, we obtain its Price to Earnings Growth (PEG) ratio of 3.59. Since a PEG ratio of 1 or less may indicate that the company's valuation is proportionate to its growth potential, we see here that GPS is overvalued when we factor growth into the price to earnings calculus.
To better understand the strength of Gap's business, we can analyze its gross profits, which are its revenues minus its cost of goods sold only. The extent of gross profit margins implies how much freedom the company has in setting the prices of its products. A wider gross profit margin indicates that a company may have a competitive advantage, as it is free to keep its product prices high relative to their cost.
GPS's average gross profit margins over the last four years are 42.1%, which indicate it has a potential competitive advantage in its market. These margins have slightly increased over the last four years, with an average growth rate of 8.4%.
Gap's financial viability can also be assessed through a review of its free cash flow trends. Free cash flow refers to the company's operating cash flows minus its capital expenditures, which are expenses related to the maintenance of fixed assets such as land, infrastructure, and equipment. Over the last four years, the trends have been as follows:
- 2021 free cash flow: $115,000,000.00
- 2020 free cash flow: $-155,000,000.00
- 2019 free cash flow: $366,000,000.00
- 2018 free cash flow: $676,000,000.00
- Average free cash flow: $250,500,000.00
- Average free cash flown growth rate: -4.7 %
- Coefficient of variability (lower numbers indicating more stability): 141.5 %
With its positive cash flow, the company can not only re-invest in its business, it can offer regular returns to its equity investors in the form of dividends. Over the last 12 months, investors in GPS have received an annualized dividend yield of 5.8% on their capital.
Value investors often analyze stocks through the lens of its Price to Book (P/B) Ratio (market value divided by book value). The book value refers to the present value of the company if the company were to sell off all of its assets and pay all of its debts today - a number whose value may differ significantly depending on the accounting method.
Gap, Inc. has a P/B ratio of 1.5. This indicates that the market value of the company exceeds its book value by a factor of more than 1, but is still below the average P/B ratio of the Consumer Cyclical sector, which stood at 3.11 as of the second quarter of 2022.
Gap, Inc. is by most measures overvalued because it has a negative P/E ratio, a lower P/B ratio than the sector average, and an irregular stream of positive cash flows with a downwards trend. The stock has mixed growth indicators because it has a an inflated PEG ratio and consistently strong gross margins that are increasing. We hope you enjoyed this overview of GPS's fundamentals. Make sure to subscribe to our free newsletter for daily equity reports.
