Over the past six months, Gap’s stock price fell to $22.76. Shareholders have lost 12.2% of their capital, which is disappointing considering the S&P 500 has climbed by 8.1%. This might have investors contemplating their next move.
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Why is Gap not exciting?
Even with the cheaper entry price, we’re sitting this one out for now. Here are three reasons why there are better opportunities than GAP, plus one stock we’d rather own.
1. Stores are closing, 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 3,471 locations in the latest quarter. Over the last two years, the company has generally closed its stores, averaging 1.1% annual declines.
When a retailer shutters stores, it usually means that brick-and-mortar demand is less than supply, and it is responding by closing underperforming locations to improve profitability.
2. Same-store sales falling behind peers
Same-store sales is a key performance indicator used to measure organic growth at brick-and-mortar shops for at least a year.
Gap’s demand within its existing locations has been relatively stable over the last two years but was below most retailers. On average, the company’s same-store sales have grown by 2% per year.
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? A company’s ROIC explains this by showing how much operating profit it makes compared 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 9.4%, somewhat low compared to the best consumer retail companies that consistently pump out 30%+.
Final judgment
Gap’s business quality ultimately falls short of our standards. Following the recent decline, the stock trades at 9.3× forward P/E (or $22.76 per share). While this valuation is optically cheap, the potential downside is big given its shaky fundamentals. We’re pretty confident there are more exciting stocks to buy at the moment. We’d recommend looking at our favorite semiconductor picks and shovels play.
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