When Gap announced yesterday that it will be missing its second- quarter earnings estimate, the market responded by sending the stock up 11%. Investors puzzled by this should remember that not all "bad news" is always bad news.

By LouAnn Lofton (TMF Lou2)
July 7, 2000

Gap, Inc. (NYSE: GPS), the Rule Making clothing retailer, announced yesterday that the company will not be meeting earnings estimates for its fiscal second quarter. They also announced that June same-store sales (or "comps) were off by 2%. The market responded by sending Gap shares up about 11%.

What gives? Shouldn't the shares have tanked? This is a classic case of seemingly bad news confirming expectations. Sometimes, bad news is actually good news.

Gap's warning is no surprise
Gap has had it rough the last couple of months. The company's fiscal first quarter was off in more ways than one. Comps were down for the quarter and also down for the past two months. Inventory is backing up at the company, and the stock recently touched down at a new 52-week low. Logically, you'd think yesterday's news would have driven the stock down -- just more bad news out from the company, right?

Not quite. The key lies in knowing that in the company's first-quarter conference call, CEO Mickey Drexler owned up to Gap's recent problems, and talked frankly about the company's plans to get back on track.

Fool analyst Bob Fredeen, who covered the conference call in his Motley Fool Research Gap quarterly update said, "It's going to take time for the changes the company talked about to have an impact. Gap can't change their product lineup instantly, they've got to design new products, find the material and get somebody to make them and ship them to the company. This quarter, Gap is going to feel the pain from fixing their problems, and it will probably be the worst quarter for them in a while."

Sometimes a warning can build confidence
Yesterday's news confirmed that the company's honest assessment of its problems back in May was right on target, and that the future for Gap as articulated by Drexler may be accurate. While the company did say that it wouldn't meet second-quarter estimates, it is still comfortable with estimates for the third and fourth quarter. That's exactly what was expected from the company. If Gap had announced that it wouldn't make estimates out past the second quarter, we probably would've seen a different market reaction.

Gap's earnings warning yesterday provides a valuable lesson for investors. Not all bad news is bad news. At first blush, an earnings warning would seem to bode poorly for a company. Having a long-term, bigger picture point of view, though, can help shareholders interpret news outside of the box. Remember that things aren't always as they immediately appear.

Your Turn:
Not convinced that yesterday's news is a postive for company? Nervous that the third and fourth quarters may not shake out as planned? Talk about it with other Fools on the Gap discussion board.

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