Benjamin Graham taught that Intelligent Investors must do a thorough fundamental analysis of investment opportunities to determine their intrinsic value and inherent risk. This is best done by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another company. By using the ModernGraham method one can review a company's historical accomplishments and determine an intrinsic value that can be compared across industries. What follows is a specific look at how The Gap Inc. fares in the ModernGraham valuation model.
GPS data by YCharts
Defensive Investor - must pass at least 6 of the following 7 tests: Score = 5/7
- Adequate Size of Enterprise - market capitalization of at least $2 billion - PASS
- Sufficiently Strong Financial Condition - current ratio greater than 2 - FAIL
- 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 - FAIL
- Moderate Price to Assets - PB ratio is less than 2.5 or PB x PEmg is less than 50 - PASS
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
Key Data:
| Recent Price | $43.68 |
| MG Value | $63.34 |
| MG Opinion | Undervalued |
| Value Based on 3% Growth | $31.84 |
| Value Based on 0% Growth | $18.67 |
| Market Implied Growth Rate | 5.70% |
| NCAV | -$0.98 |
| PEmg | 19.89 |
| Current Ratio | 1.67 |
| PB Ratio | 6.63 |
Balance Sheet - 10/31/2013
| Current Assets | $4,390,000,000 |
| Current Liabilities | $2,631,000,000 |
| Total Debt | $1,247,000,000 |
| Total Assets | $7,786,000,000 |
| Intangible Assets | $276,000,000 |
| Total Liabilities | $4,830,000,000 |
| Outstanding Shares | 449,000,000 |
Earnings Per Share
| 2014 (estimate) | $2.72 |
| 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 - ModernGraham
| 2014 (estimate) | $2.20 |
| 2013 | $1.87 |
| 2012 | $1.59 |
| 2011 | $1.52 |
| 2010 | $1.31 |
| 2009 | $1.17 |
Dividend History
GPS Dividend data by YCharts
Conclusion:
The Gap Inc. is not suitable for the Defensive Investor but is suitable for the Enterprising Investor. The Defensive Investor is not interested because of the company's low current ratio and high PEmg ratio. In the eyes of the Enterprising Investor, the company is very intriguing, after passing all five of the investor type's requirements. As a result, Enterprising Investors following the ModernGraham approach based on Benjamin Graham's methods should feel comfortable proceeding with further research into the company, though they should keep in mind the 7 Key Tips to Value Investing as they do so and review other opportunities such as 5 Low PEmg Companies for the Enterprising Investor.
From a valuation standpoint, the company has grown its EPSmg (normalized earnings) from $1.31 in 2010 to an estimated $2.20 for 2014. This level of demonstrated historical growth outpaces the market's current implied estimate of earnings growth of 5.7%, and the company would appear to be undervalued by the ModernGraham valuation model.
The next part of the analysis is up to individual investors, and requires discussion of the company's prospects. What do you think? What value would you put on The Gap Inc.? Where do you see the company going in the future? Is there a company you like better?
Disclosure: The author did not hold a position in The Gap Inc. (GPS) or any of the other companies listed in this article at the time of publication and had no intention of changing that position within the next 72 hours.
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