Is Gap Stock Overvalued or Undervalued?

A sign hangs above the entrance of a Gap store in Chicago, Ill., Oct. 13. Gap Inc. plans to reduce the number of Gap brand stores to 700 in North America, closing roughly one-third of its existing stores by the end of 2013. (Scott Olson/Getty Images)

Gap Inc shares have lagged the S&P 500 in 2021, generating a year-to-date total return loss of 9.2 percent.

Gap stock has had a wild ride in recent years, but investors may be wondering whether there’s any value in Gap shares after the recent pullback.

Earnings

A price-to-earnings ratio (PE) is one of the most basic fundamental metrics for gauging a stock’s value. The lower the PE, the higher the value.

For comparison, the S&P 500’s PE is currently at about 29.6, nearly double its long-term average of 15.9. Gap’s PE is 14.2, less than half the S&P 500 average as a whole.

Growth

Looking ahead to the next four quarters, the S&P 500’s forward PE ratio looks much more reasonable at just 21.4. Gap’s forward earnings multiple of 9.4 is still less than half the S&P 500’s, making Gap look undervalued.

Gap’s forward PE ratio is also less than a third the average multiple of its consumer discretionary sector peers, which are averaging a 32.9 forward earnings multiple.

Yet when it comes to evaluating a stock, earnings aren’t everything.

The growth rate is also critical for companies that are rapidly building their bottom lines. The price-to-earnings-to-growth ratio (PEG) is a good way to incorporate growth rates into the evaluation process. The S&P 500’s overall PEG is currently about 1.0; Gap’s PEG is 2.9, suggesting Gap is still overvalued after accounting for its growth.

Price-to-sales ratio is another important valuation metric, particularly for unprofitable companies and growth stocks. The S&P 500’s PS ratio is currently 3.22, well above its long-term average of 1.63. Gap’s PS ratio is 0.55, an extreme discount to the S&P 500 average as a whole. Gap’s PS ratio is also down 37.8 percent over the past five years, suggesting the stock is priced at the low end of its historical valuation range.

Finally, Wall Street analysts see value in Gap stock over the next 12 months. The average analyst price target among the 20 analysts covering Gap is $25.50, suggesting 39.5 percent upside from current levels.

Verdict

At its current price, Gap stock appears to be undervalued based on a sampling of common fundamental valuation metrics.

By Wayne Duggan

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