Gap’s 23.4% return over the past six months has outpaced the S&P 500 by 17.3%, and its stock price has climbed to $26.75 per share. This performance may have investors wondering how to approach the situation.
Is there a buying opportunity in Gap, or does it present a risk to your portfolio? Get the full breakdown from our expert analysts, it’s free.
Why Is Gap Not Exciting?
Despite the momentum, we're swiping left on Gap for now. Here are three reasons we avoid GAP and a stock we'd rather own.
1. Long-Term Revenue Growth Flatter Than a Pancake
A company’s long-term sales performance can indicate its overall quality. Any business can have short-term success, but a top-tier one grows for years. Unfortunately, Gap struggled to consistently increase demand as its $15.37 billion of sales for the trailing 12 months was close to its revenue three years ago. This was below our standards and is a sign of lacking business quality.
2. Lack of New Stores, a Headwind for Revenue
The number of stores a retailer operates is a critical driver of how quickly company-level sales can grow.
Gap operated 3,474 locations in the latest quarter, and over the last two years, has kept its store count flat while other consumer retail businesses have opted for growth.
When a retailer keeps its store footprint steady, it usually means demand is stable and it’s focusing on operational efficiency to increase profitability.
3. Previous Growth Initiatives Haven’t Impressed
Growth gives us insight into a company’s long-term potential, but how capital-efficient was that growth? Enter ROIC, a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).
Gap historically did a mediocre job investing in profitable growth initiatives. Its five-year average ROIC was 7.6%, somewhat low compared to the best consumer retail companies that consistently pump out 25%+.
Final Judgment
Gap isn’t a terrible business, but it doesn’t pass our quality test. With its shares beating the market recently, the stock trades at 11.8× forward P/E (or $26.75 per share). While this valuation is fair, the upside isn’t great compared to the potential downside. We're pretty confident there are superior stocks to buy right now. We’d suggest looking at a safe-and-steady industrials business benefiting from an upgrade cycle.
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