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The Gap Is No Longer It

The Gap LogoFor a very long time, Gap Inc. (NYSE:GPS) ruled the clothing world. It was a robust growing company with strong cash flow, a solid brand name and clothes that always seemed to be in style. Yet a few years ago, ever-fickle consumers got distracted by flashy competitors, and Gap started to lose market share.

Such is the ongoing battle that clothing retailers must deal with, and it will never end. Now, with so many retailers fighting for space in the malls — and the economy rebounding slightly — competition will only intensify.

Gap still makes quality products and offers them at good prices. Yet times have changed, and what was once a slam-dunk stock to own has been relegated to the discount bin.

Now, it’s not like the company is going under, but profit is falling. Fourth-quarter income was down almost 30%, and full-year income was down 17%. Full-year sales were down 1%, with comparable-store sales down 4%. These negative comps were consistent across all of the company’s stores — Gap, Banana Republic, Old Navy. International stores in particular really took it on chin — down 8% in Q4 and 7% for the year.

There is plenty of good news for Gap, and most it resides on its balance sheet. There’s $1.9 billion in cash, offset by $1.6 billion in debt. Free cash flow, while down in 2011, still was a very impressive $815 million. That left Gap enough to repurchase 111 million shares last year, and it has another $1 billion authorized to buy. The company still pays a 2% dividend, with a 10% increase for this year.

Gap also delivered a pleasant surprise yesterday after it reported same-store sales increased 4% in February, whereas analysts expected a 1.4% decrease.

So what might help the company turn things around? It has one thing going for it organically, and it’s the same thing that has lifted The Buckle (NYSE:BKE). Both stores very much take a “back to basics” approach, eschewing the passing trends, although I consider Gap to be a kind of hybrid. The Buckle is totally unpretentious and doesn’t pander to the fashionista consumer. The Gap has a slightly trendier way about it, but not overwhelmingly so. That also might be a shortcoming, however, in that it straddles categories rather than commits.

The other thing that might help is some kind of revolutionary concept reinvention, much along the lines of J.C. Penney (NYSE:JCP). I imagine many retailers are watching how Penney’s new concept is going to perform, and my gut tells me it’s going to do very well and spark competitors. I’m not saying the exact same concept will work for Gap, but the notion of a brand reinvention might be what the doctor ordered.

The company is guiding to $1.75 to $1.80 in earnings next year — that’s 12% to 15% growth off of this difficult year. I just don’t know if those numbers are realistic, though. It trades at a P/E of 14 times next year’s earnings, so at best, it’s fairly valued. I would not get involved in buying the stock until Gap proves the turnaround is for real, and I would consider selling for the same reason.

As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Capital, Inc., which brokers secure high-yield investments to the general public and private equity. You can read his stock market commentary at He also has written two books and blogs about public policy, journalistic integrity, popular culture and world affairs.

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