August 13, 1996
The Gap Inc. (NYSE: GPS)
Type: Large-Cap Growth
Phone: (415) 952-4400
Closing Prices, August 12th, 1996: Bid $36 Ask: $36 1/8
Trailing 12-month revenues: $4.7 billion
Trailing 12-month EPS: $1.34
Last quarter reported: April, 1996 (FY: Dec)
Next quarter reported date: 2Q, August 14, 1996
Consensus EPS estimates for quarter: $0.18e vs. $0.11
FOOL ratio: 1.06
FOOL YPEG: .99
---->Trade: Selling 310 shares
On April 20, 1995, we went to the public markets to dig up 155 shares of retailing giant, Gap (NYSE:GPS), at approximately $31.50 per share. Since that time, the stock split 2-for-1, leaving us with 310 shares and a cost-basis of $16.28 per share.
Today, we announce our intent to return our 310-share position in The Gap back to the marketplace, after recording profits of 122.0% in sixteen months. During the period of our GPS ownership, the Standard & Poor's 500 rose 31.8%. Over the same period, the Foolish Four Dow stocks have gained approximately 50%.
What you see here then is a replication of the stated aims of The Motley Fool Portfolio. With our savings money, we aim first and foremost to outperform the returns of the Standard & Poor's 500, which is easily duplicated via the Vanguard S&P Index Fund. If you can't beat it, join it. We believe we can effortlessly do just that via the Dow Dividend approach and our Foolish Four model, which has compounded 22.0% annually over the past 26 years.
Veteran Fool readers know that at a rate of 22% annual growth, a single dollar in a tax-deferred account would bloom into $350 million over a one-hundred-year period. So we feel reasonably confident that our savings account will benefit us, and our children and theirs -- generations hence -- if we maintain as a baseline that discipline of high-yield Dow stock investing, as identified in The Motley Fool Investment Guide.
But we're enterprising and curious Fools. We like to seize on opportunities when they appear to present themselves. Thus, we believe that diligent and patient individual investors can outperform 22% historical annual growth, much to the discomfort of the Wise. By focusing attention on companies that provide superior services and products, that generate healthy margins of profit, that are not debtors, and that seem to hold their shareholders dear, I think investors greatly improve the odds of outrunning the Foolish Four.
Gap was just that sort of investment for us.
Thankfully, the retailer leapt every bar we raised in front of it. The Company expanded margins, increased sales substantially, generated robust cashflows, did not defer costs or compromise future growth with heavy borrowing, did a bang-up job of marketing the Gap experience, and handsomely rewarded shareholders. We never would have made this investment without first stabilizing The Fool Port with heavier Dow issues. Once done, though, you know we love to track down branded, profitable, healthy growth.
WHAT HAPPENED OUT THERE
Every time long-term investors transact out of an ownership position, they should set a few minutes aside and ask themselves, "Hey, what happened out there? How did my company do? What business lessons have I learned from them? Which of my initial expectations were met, which exceeded, which undershot?"
I think the first step is simply to review your notes. With The Fool Portfolio, you can start with our Gap Information Collection, which is available in the listbox on our portfolio-report screen. It includes our purchase report, a thorough analysis of the Company's prospects back in April, 1995. I know it's more fun to think about the future, but I do recommend taking some time offline or online to review that initial Gap buy report. The business lessons are all there.
Gap did a wonderful job in 1995 of turning a dismal retailing environment into an opportunity for market-share expansion. They polished up their Gap stores, continued to move aggressively into infants' and children's attire, and literally blitzed the lower-end apparel market with their Old Navy superstores. To be certain, it was a gutsy move by the San-Francisco retailer. But I think online Fool, Bradstoker, eloquently phrased Gap's intent in a recent note in the stock's folder:
"While Old Navy seems to be cannibalizing Gap sales, I like to look at it as a diversification play. A great situation is to have another division of the same company as your worst competition."
Too true. Why let others undercut your pricing when you have the resources, the sophistication, and the confidence to do it yourself? Not surprisingly, in the end, the success of the Old Navy stores has served to broaden the Company's reach far more than cannibalize existing sales at lower margins.
And it is that broad reach that makes Gap so compelling to Wall Street. Gap apparel is out there on the heads, shoulders, legs, and feet of Americans of all shapes, sizes, and ages. This is a preeminent consumer company and brand. It has designed products to meet all-inclusive price points. And it has branded the entire production with a commitment to casual clothing for everyone, from CEOs to students, from toddlers to retirees.
In matters financial, management has been marked by excellence as well. Gap maintained 8 percent margins through a difficult year. Cash and equivalents continued to outpace current liabilities. Current assets rested comfortably ten times above long-term debt obligations. Sales and earnings---again in a challenging environment---rose 18% and 11% respectively. Additionally, Gap hiked its dividends by 14% in 1995.
And Gap continued its pursuit of methodical growth, opening 225 stores and closing 53 during the year. The Company supported the growth with a spirited marketing plan, and continued to dedicate itself to managing a company for shareholders that is flush with cash.
WHY THE HECK ARE WE SELLING?
"So why in the world would The Fool cash out of this position?"
Darn good question. There are plenty of compelling reasons to hold on tight. The business and stock have been monster winners for many years. In its April 29th issue, Fortune Magazine listed the fifty US companies that had generated the highest total return for investors over the past decade. Our fair company, The Gap, came in 13th place---its stock having generated 28.4% annual growth since 1985 (cf. Fortune's Top 50). Gap fell two slots and one-percentage-point per year behind Berkshire Hathaway. For eager statisticians like we, let's compound this out in dollar terms. $10,000 invested in Gap a decade ago is now worth over $121,800 (pre-tax).
And Gap's strong performance doesn't appear a thing of the past to motley eyes. Analysts have been upgrading estimates over the past quarter; fiscal 1997 earnings-per-share (EPS) projections have been hiked all the way up to $1.97. When the Company announces its 2Q numbers this week, we reckon it'll outdo mean Street estimates of $0.18. Last quarter, they beat expectations by 17%. But, most importantly, we believe that Gap's short-term earnings performance is indicative of a healthy and defensible growth over the intermediate and long term. Barring unforeseen trauma, GPS shares should markedly outperform the S&P 500 in the decade ahead.
"So why sell now?"
Well, the retailing business is, by definition, a cyclical one. When the economy sparkles, consumer purchasing heats up. But when economic growth slows, our citizenry gets tight with the cash, stops eating out three nights a week, and opts to wear that same business outfit even after the seams are in disrepair.
Finger up in the air and ear to the ground, we sense that macroeconomic growth in America is flourishing. When will it slow? Well, economists with an eye on the political arena, like Macrodata in our Economy folder, have duly noted that the Fed is loathe to hike rates during presidential campaigns. They look for neutral sidelines. Not surprisingly then, presidential years are historically inflationary years. Loads of cash rolls into the marketplace, fueling growth, while interest rates are held in check. What tends to happen after the election results have been tabulated?
Interest rates head higher, the speedy growth slackens, and retailing stocks can fall out of favor. As MF Bogey has noted, the time to look for bargain prices among retail issues is when overall economic growth is moderate to sluggish, when Wall Street is bad-mouthing the group, when retail stocks are notably down from few-year highs. Contrarily, the time to cash out of them is when the market adores them, when economic growth is above-average, with interest rates locked. . . heck, just before the presidential debates begin.
But there's a flaw to this analysis! The Gap ain't really a cyclical. We're not talking about high-priced items here: couches, entertainment centers, lifesized Barney paraphernalia. Consumers pull back in lean times, but ole Gap hits 'em at price points they can still meet and with products they need: casual clothing. That's why GPS has compounded 28% annual growth. It ain't your average retailer.
And Gap's financial strength enables them to gobble up market-share in dark hours, when their competition is hurting. Desperate times for the industry can actually present Gap with opportunities. Now certainly, there are good times and bad times for GPS stock. But when you recognize it as a growth business, resilient through economic downtime, and when you patch together its long-term performance, it all comes up smelling a rose.
WHY WE ARE SELLING
"Ok. . . so why sell now?"
The primary reason we're selling our Gap shares was succinctly put by David in The Motley Fool Investment Guide, in the chapter entitled "Selling Strategies":
When you find a better place for your money, put it there.
We believe that we've located a better place for our nearly 11K bucks' worth of Gap. In tonight's buy writeup on computer networking giant, 3Com (NASDAQ:COMS), we state expectations for a double over the succeeding twelve months. Tapping the figures into our handy Windows scientific calculator, Gap looks to have 15-20% of growth potential in the year ahead, or pricing in the low-$40s. Doesn't quite match up with our 100% hopes for COMS.
Keep in mind that every step of the way, our price targeting for the Gap has fallen short. When we purchased the stock at $16 1/4 (split-adjusted), we were looking for $20-$22 a share. When the company closed out its 4th quarter in 1995, with the stock trading at $27 3/4, we labeled the issue fairly priced and hinted at plans to close out our position. Now here we are six months later, with the stock at $35 per stub---more than 70% above our initial target price, and 26% above its position at the end of fiscal 1995. Who knows whether $40-$42 price for GPS over the next 12 months will once again prove too conservative? And. . . who knows what lurks in the hearts of men?
Only The Shadow knows.
Sixteen months back we dipped into the world of highly-profitable, large-capitalization stocks and found in excess of 100% returns. We're hoping to have found just that in 3Com. Time will tell. If not, well, we hope COMS beats Foolish Four returns. If not, gads, we hope COMS beats the market. But we'll certainly be comparing the performance of 3Com against that of its Californian sibling, Da Gap, to see if we truly did find a better place for our money here.
We love The Gap. In my review of their fourth quarter, I wrote, "We love the idea of Go-To stocks... meaning we will always be keeping tabs on this retailer, looking for buying opportunities (in it) for years and years, and years, to come."
Just because we're parting ways now, this does not mean that we're abandoning the enterprise. Expect to see Gap shares re-enter The Fool Portfolio at some point in the next decade. . .when the market groups it with lesser businesses and drops GPS shares after a slow Christmas.
To clarify, we don't see much reason to research four thousand different businesses in our lifetime. Not when we've been able to identify what we think of as a bullpen of greatly profitable, financially mighty, shareholder-friendly businesses to buy when the prices are right. Gap is in that bullpen. It will get the nod to throw more innings in the many years ahead.
As the giant lumbers back into the dugout in faded jeans, cotton t-shirt, and Gap cap, having added another win to his Hall-of-Famer's record, howsabout you lean over the railing with us and give him a few hoots of support? Whether or not you own GPS shares, whether you plan to hold 'em or fold 'em here, consider giving the Company a thank-you call (415-952-4400) for its performance and the dedication of its 60,000 employees worldwide.
-- Tom Gardner