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The Gap, Inc. (NYSE:GAP) shareholders might be concerned after seeing the share price drop 21% in the last quarter. But that doesn't change the fact that shareholders have received really good returns over the last five years. We think most investors would be happy with the 110% return, over that period. To some, the recent pullback wouldn't be surprising after such a fast rise. The more important question is whether the stock is too cheap or too expensive today.
In light of the stock dropping 6.3% in the past week, we want to investigate the longer term story, and see if fundamentals have been the driver of the company's positive five-year return.
There is no denying that markets are sometimes efficient, but prices do not always reflect underlying business performance. One flawed but reasonable way to assess how sentiment around a company has changed is to compare the earnings per share (EPS) with the share price.
Over half a decade, Gap managed to grow its earnings per share at 19% a year. So the EPS growth rate is rather close to the annualized share price gain of 16% per year. This indicates that investor sentiment towards the company has not changed a great deal. In fact, the share price seems to largely reflect the EPS growth.
The company's earnings per share (over time) is depicted in the image below (click to see the exact numbers).
It is of course excellent to see how Gap has grown profits over the years, but the future is more important for shareholders. You can see how its balance sheet has strengthened (or weakened) over time in this free interactive graphic .
What About Dividends?
It is important to consider the total shareholder return, as well as the share price return, for any given stock. The TSR incorporates the value of any spin-offs or discounted capital raisings, along with any dividends, based on the assumption that the dividends are reinvested. It's fair to say that the TSR gives a more complete picture for stocks that pay a dividend. As it happens, Gap's TSR for the last 5 years was 147%, which exceeds the share price return mentioned earlier. And there's no prize for guessing that the dividend payments largely explain the divergence!
A Different Perspective
We regret to report that Gap shareholders are down 19% for the year (even including dividends). Unfortunately, that's worse than the broader market decline of 2.0%. However, it could simply be that the share price has been impacted by broader market jitters. It might be worth keeping an eye on the fundamentals, in case there's a good opportunity. On the bright side, long term shareholders have made money, with a gain of 20% per year over half a decade. If the fundamental data continues to indicate long term sustainable growth, the current sell-off could be an opportunity worth considering. While it is well worth considering the different impacts that market conditions can have on the share price, there are other factors that are even more important. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Gap , and understanding them should be part of your investment process.