The Gap Is Back

Back in August, Morning Monte looked at Gap Inc. at $24.01 a share, and saw potential.  Today the Gap Inc GPS is back on our radar having fallen over 16.6% percent on Friday. So here we are scratching our heads again about how such a large company can be so volatile.  We don’t claim to have an infallible crystal ball at Morning Monte, but we are happy when we are (at least temporarily) right about something.  After our piece, Gap did end up hitting $30/share over just a couple of months.

That would be a fine return if you had your own crystal ball and could see to sell it at $30.  Ah if only…  We do think that it is interesting that $30/share was at the high end of what our model was saying was fair at that time.

Stephen Penman is fond of saying “Ignore new information at your peril.”  Friday’s report was indeed new (unfavorable) information that brought the stock back down to $25.61.  However, we thought it was time to take another look.

Before we do, we can’t help but to enjoy the financial press a bit.  I do find the financial press entertaining–if unfortunately not usually helpful.  Gap Shares Flop After Chain Says It Will Close More Stores Than Expected says Reuters reprinted in Fortune.   That is at least factually correct.  Nightmare continues for Gap and Abercrombie & Fitch proclaims CNN Money.  The Biggest Loser trumpets Yahoo! Finance. The trouble with headlines, as with many headlines, is that there is no context.  The Gap was up over 27% since August.  Sure, Friday the 18th wasn’t a great day, but it isn’t like the stock has been completely tanking.  It is down a bit since last November when it was about $27, but factoring in the dividend, an investor was really just out her cost of capital.  This is hardly a tragedy in the investing world.  You want tragedy, see Enron.  The issue with the Gap right now is that it is wildly volatile.  Sometimes volatility is opportunity.  With that in mind, let’s take a look at the numbers.  You know how we love the accounting…

Our simple value breakdown shows that most of the value of the Gap is in the earning.  Not too much is in growth, and given the recent news.  Same-store sales plunged 8% at both Gap and Banana Republic.

I thought that a look at the simple Monte Carlo was particularly interesting.

As always, we encourage you to play with the inputs to see what you get.  A high-level take away for us is that the Gap seems to be fairly valued right now.  This is somewhat in line with our last discussion of the Gap.  Then we thought it was undervalued at a similar price.  There has been some bad news, so it makes sense that the Monte Carlo now shows less of an opportunity.  Of course, to see if their is an opportunity, you would have to dig into the earnings and market details.

However, keep in mind that in our model “fairly valued” means that we expect an 8% return on our money–which isn’t bad.  For now, we plan to keep an eye on it.  If it keeps falling from where it is, the market may be overreacting to some bad news.  For us, that could be a great thing.

The author currently does not hold a position in the Gap.

Morning Monte is “high-level,” and any investment requires a deeper analysis than is presented here. The comments in The Morning Monte are intended to help guide your research and ground you in the fundamentals. In no way should the comments in The Morning Monte be taken as advice to buy or sell a particular equity. Some of the statements are forward looking. As such, these statements are speculation–so beware! The comments represent the views of the author and are not necessarily the views of Morning Monte™ or PRUDENA™.