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Why is the Gap Case Interesting?

Why is the Gap Case Interesting?. Gap’s earnings had been increasing steadily through the date of the case Gap’s stock price was $55/share, or 35 times of earnings Why is The Gap’s P/E so high? Good earnings expectation? Too optimistic?. The Specialty Retailing Industry.

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Why is the Gap Case Interesting?

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  1. Why is the Gap Case Interesting? • Gap’s earnings had been increasing steadily through the date of the case • Gap’s stock price was $55/share, or 35 times of earnings • Why is The Gap’s P/E so high? • Good earnings expectation? • Too optimistic?

  2. The Specialty Retailing Industry • Growth is not expected to exceed overall economy-wide expansion • High level of competition • Many competitors • Low customers’ switching costs • Few barriers to entry • “Brand name” is not a crucial factor to scare new entrants

  3. Determinants of Profitability • Profit margin • High sales • High gross margin • Low operating expense

  4. Gap’s Business Strategy • Product differentiation strategy • Niche market: brand name at a moderate price • Brand development • Unique advertising • High sales; low operating expense; high inventory turnover

  5. High ROE and Why? Gap Limited Industry 1989 31.8% 31.7% 22.6% 1990 36.0% 28.5% 21.1% 1991 40.2% 23.5% 19.6% Observation: Gap’s ROE has been increasing and is much higher than The Limited and its industry average

  6. Accounting “Tricks”? • Probably not… • Unusual large amount of earnings? • Earnings too much higher than OCF? • Abnormal changes in inventory? • Receivables too high? • And, leases?

  7. Decomposition of ROE-1991 PM Turnover Leverage Gap 9.2% 2.618 1.683 Limited 7.0% 1.997 1.830 Industry 5.3% 2.141 1.874 Observation: Gap had high profit margin and assets turnover High gross margin High fixed assets turnover; investment in receivable is nearly zero!

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