Investing in Gap (NYSE:GAP) three years ago would have delivered you a 80% gain

By buying an index fund, investors can approximate the average market return. But if you buy good businesses at attractive prices, your portfolio returns could exceed the average market return. Just take a look at The Gap, Inc. (NYSE:GAP), which is up 57%, over three years, soundly beating the market return of 36% (not including dividends). On the other hand, the returns haven't been quite so good recently, with shareholders up just 18%, including dividends.

Now it's worth having a look at the company's fundamentals too, because that will help us determine if the long term shareholder return has matched the performance of the underlying business.

View our latest analysis for Gap

In his essay The Superinvestors of Graham-and-Doddsville Warren Buffett described how share prices do not always rationally reflect the value of a business. One imperfect but simple way to consider how the market perception of a company has shifted is to compare the change in the earnings per share (EPS) with the share price movement.

Gap was able to grow its EPS at 18% per year over three years, sending the share price higher. We don't think it is entirely coincidental that the EPS growth is reasonably close to the 16% average annual increase in the share price. This observation indicates that the market's attitude to the business hasn't changed all that much. Au contraire, the share price change has arguably mimicked the EPS growth.

The image below shows how EPS has tracked over time (if you click on the image you can see greater detail).

We know that Gap has improved its bottom line lately, but is it going to grow revenue? You could check out this free report showing analyst revenue forecasts.

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 is a return calculation that accounts for the value of cash dividends (assuming that any dividend received was reinvested) and the calculated value of any discounted capital raisings and spin-offs. So for companies that pay a generous dividend, the TSR is often a lot higher than the share price return. As it happens, Gap's TSR for the last 3 years was 80%, 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

Gap provided a TSR of 18% over the last twelve months. Unfortunately this falls short of the market return. The silver lining is that the gain was actually better than the average annual return of 9% per year over five year. This suggests the company might be improving over time. It's always interesting to track share price performance over the longer term. But to understand Gap better, we need to consider many other factors. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Gap , and understanding them should be part of your investment process.

But note: Gap may not be the best stock to buy. So take a peek at this free list of interesting companies with past earnings growth (and further growth forecast).

Please note, the market returns quoted in this article reflect the market weighted average returns of stocks that currently trade on American exchanges.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.