Polo or Gap? That is the question. Truth be told, I've played golf just about all my life and I must admit I'm pretty stuck on Polo. However, what about when it comes to money? Are you better off plunking down your hard-earned bucks on a few shares of Polo Ralph Lauren (NYSE: RL ) ? Or is Gap (NYSE: GPS ) the sartorial solution for your portfolio? By taking a look at a few common ratios over time, we can certainly get a better idea as to which company may be the better bet.
Return on equity
Warren Buffett likes looking at a company's return on equity because it is a key indicator as to not only how profitable the business is, but also how well the company's assets and leverage are being managed. Think about it this way: A company earning $1 million in a given year on $5 million in shareholders' equity is doing a better job than another company earning $1 million on $20 million in shareholders' equity. This is what return on equity tells us. So how do Polo Ralph Lauren and Gap measure up here? Let's take a look:
|
Company
|
TTM
|
2010
|
2009
|
2008
|
2007
|
5-Year Avg.
|
|
Polo Ralph Lauren
|
18.1%
|
16.4%
|
15.8%
|
17.8%
|
18.3%
|
17.3%
|
|
Gap
|
26.3%
|
23.8%
|
22.3%
|
18.4%
|
15.3%
|
21.2%
|
Source: Capital IQ, a division of Standard & Poor's. TTM=trailing 12 months.
Based on the five-year averages here, Gap is establishing a gap between the two companies.
Operating margin
When we talk about margins, a good one to focus on is the operating margin, also known as the EBIT margin (earnings before interest and taxes). These are the earnings that take into account the company's operating expenses and this can tell us how much the company is spending to operate the business. I mean let's face it, earning $1 million isn't going to mean much if it costs you $950,000 to do it.
So how do these two compare? Here are the figures:
|
Company
|
TTM
|
2010
|
2009
|
2008
|
2007
|
5-Year Avg.
|
|
Polo Ralph Lauren
|
15.3%
|
14.5%
|
13.4%
|
13.4%
|
15.3%
|
14.4%
|
|
Gap
|
13.6%
|
12.9%
|
10.7%
|
8.4%
|
7.8%
|
10.7%
|
Source: Capital IQ, a division of Standard & Poor's.
Polo Ralph Lauren holds the edge when it comes to EBIT margins. Though I bet both companies would admire Guess?'s (NYSE: GES ) five-year 17.1% average.
Free cash flow margin
Finally, I like to take a look at the free cash flow margin. While slightly more involved, it can really shed light on what the company is actually making once it is all said and done. Free cash flow is one of our favorite numbers to look at. Simply defined as cash flow from operations less capital expenditures, free cash flow is that money that is left after all of the bills have been paid. It is the money that the company can return to shareholders in one fashion or another. Be it in the form of dividends, share buybacks or even reinvesting in the business. The free cash flow margin is a comparison of the free cash flow the company is generating to its revenues.
Let's see how the two match up:
|
Company
|
TTM
|
2010
|
2009
|
2008
|
2007
|
5 Yr. Avg.
|
|
Polo Ralph Lauren
|
11%
|
14.2%
|
11.7%
|
9.8%
|
14.3%
|
12.2%
|
|
Gap
|
9%
|
11.2%
|
6.8%
|
8.9%
|
4.3%
|
8%
|
Source: Capital IQ, a division of Standard & Poor's.
A pretty significant difference here; Polo Ralph Lauren is galloping away with the cash.
And the winner is ...
When we consider these three metrics in assessing both businesses I give Polo Ralph Lauren the edge here. Granted they don't match Gap's returns on equity. But they sure make up for it with significantly better operating and free cash flow margins. While these aren't the only metrics to consider when assessing a business, they can provide a good starting point for further research. To be sure, both are quality businesses and worthy of consideration. But on this day, Polo Ralph Lauren is the Foolish winner.
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