Here is a look at how Gap Inc. (GPS) fares in ModernGraham's opinion, based on an updated and modernized version of Benjamin Graham's requirements of defensive and enterprising investors from The Intelligent Investor:
Defensive and Enterprising Investor Tests (What is the significance of these tests, and what is PEmg ratio?) :
Defensive Investor - must pass at least 6 of the following 7 tests: Score = 6/7
- Adequate Size of Enterprise - market capitalization of at least $2 billion - PASS
- Sufficiently Strong Financial Condition - current ratio greater than 2 - PASS
- Earnings Stability - positive earnings per share for at least 10 straight years - PASS
- Dividend Record - has paid a dividend for at least 10 straight years - PASS
- Earnings Growth - earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period - PASS
- Moderate PEmg ratio - PEmg is less than 20 - PASS
- Moderate Price to Assets - PB ratio is less than 2.5 or PB x PEmg is less than 50 - FAIL
Enterprising Investor - must pass at least 4 of the following 5 tests or be suitable for a defensive investor: Score = 5/5
- Sufficiently Strong Financial Condition, Part 1 - current ratio greater than 1.5 - PASS
- Sufficiently Strong Financial Condition, Part 2 - Debt to Net Current Assets ratio less than 1.1 - PASS
- Earnings Stability - positive earnings per share for at least 5 years - PASS
- Dividend Record - currently pays a dividend - PASS
- Earnings growth - EPSmg greater than 5 years ago - PASS
Valuation Summary (Explanation of the ModernGraham Valuation Model)
Key Data:
| MG Value | $61.50 |
| MG Opinion | Undervalued |
| Value Based on 3% Growth | $31.50 |
| Value Based on 0% Growth | $18.47 |
| Market Implied Growth Rate | 5.18% |
| NCAV | $0.26 |
| PEmg | 18.86 |
| Current Ratio | 2.01 |
| PB Ratio | 5.54 |
Balance Sheet - 7/31/2013
| Current Assets | $4,586,000,000 |
| Current Liabilities | $2,278,000,000 |
| Total Debt | $1,247,000,000 |
| Total Assets | $7,920,000,000 |
| Intangible Assets | $280,000,000 |
| Total Liabilities | $4,462,000,000 |
| Outstanding Shares | 468,000,000 |
Earnings Per Share - Diluted
| 2014 (estimate) | $2.65 |
| 2013 | $2.33 |
| 2012 | $1.56 |
| 2011 | $1.88 |
| 2010 | $1.58 |
| 2009 | $1.34 |
| 2008 | $1.09 |
| 2007 | $0.93 |
| 2006 | $1.24 |
| 2005 | $1.21 |
| 2004 | $1.04 |
| 2003 | $0.54 |
Earnings Per Share - Modern Graham (Calculating EPSmg)
| 2014 (estimate) | $2.17 |
| 2013 | $1.87 |
| 2012 | $1.59 |
| 2011 | $1.52 |
| 2010 | $1.31 |
| 2009 | $1.17 |
Conclusion:
Gap Inc. is a very attractive company for both Defensive Investors and Enterprising Investors. The company has very strong financials, having passed all of the requirements for either investor type, with the exception of the price to book ratio requirement of the Defensive Investor. From a valuation perspective, Gap has grown its EPSmg (normalized earnings) from $1.17 in 2009 to an estimated $2.17 for 2014, and has done so through consistent annual growth. As a result, the ModernGraham valuation model looks very favorably on the company, and it appears to be undervalued with respect to the market's implied growth rate of 5.18%. Potential investors should feel comfortable doing further research on this company (though, as always you should speak with a registered broker or investment advisor before making any decisions based on your individual portfolio!).
What do you think? Is Gap Inc. undervalued? Is the company suitable for both Defensive Investors and Enterprising Investors?
Disclosure: The author did not hold a position in Gap Inc. at the time of publication and had no intention of entering into a position within the next 72 hours.
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