The Gap, Inc.'s (NYSE:GAP) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

Gap (NYSE:GAP) has had a rough three months with its share price down 17%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Gap's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How To Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Gap is:

26% = US$844m ÷ US$3.3b (Based on the trailing twelve months to February 2025).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.26 in profit.

View our latest analysis for Gap

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Gap's Earnings Growth And 26% ROE

To begin with, Gap has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 18% the company's ROE is quite impressive. Under the circumstances, Gap's considerable five year net income growth of 49% was to be expected.

Next, on comparing with the industry net income growth, we found that Gap's growth is quite high when compared to the industry average growth of 14% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Gap is trading on a high P/E or a low P/E, relative to its industry.

Is Gap Making Efficient Use Of Its Profits?

The three-year median payout ratio for Gap is 28%, which is moderately low. The company is retaining the remaining 72%. By the looks of it, the dividend is well covered and Gap is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Additionally, Gap has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 25% of its profits over the next three years. Accordingly, forecasts suggest that Gap's future ROE will be 22% which is again, similar to the current ROE.

Conclusion

In total, we are pretty happy with Gap's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.