Download Table I - Specialty Retailers Industry Composite

The GAP, Inc. Case
1. Describe the features of the specialty retailing industry that determine its profit potential.
How difficult is it to earn abnormally high profits in this industry?
The features of the specialty retailing industry that determine its profit potential can be defined
by examining the five competitive forces that act on a firm. These forces include the degree of
rivalry, threat of entry, threat of substitutes, buyer power, and supplier power.
In the specialty retailing industry there are a large number of firms competing for the same
consumer dollars. Each firm can potentially offer virtually the same products. Specialty
retailers also face competition from all other types of retailers such as discount chains (e.g. TJ
Max), traditional department stores (e.g. J.C. Penny) and mass merchants (e.g. Wal-Mart). The
intense rivalry in the specialty retailing industry reduces profitability.
Barriers to new entry in the specialty retailing industry are few since access to merchandise is not
limited and there is virtually no learning curve associated with selling products. Of course, as
the scale of the operation increases barriers to entry accelerate. A large scale, national retailing
effort may entail massive investments in distribution centers, contracts with clothing
manufacturers, and significant capital requirements for retail space. While there are few barriers
to entry to open a single store, there are generally high barriers to launch a national retailing
chain. Large incumbents in the industry enjoy economies of scale, prime retail locations, and
other advantages that may thwart new entrants. Overall, the profit potential of the specialty
retailing industry is reduced because of the threat of new entrants.
The specialty retailing industry is marked by a small degree of buyer power. There are a large
number of consumers making small individual purchases, resulting in little buying power per
individual. However, when viewed as group, key buying segments have significant power to
impact firms. Consumption decisions of fickle teens may make or break a company of any size.
For the dominant firms in the specialty retailing industry, suppliers have small degree of power.
For example, in Gap’s case, no supplier provides more than 5% of the firm’s merchandise.
Smaller firms in the industry probably face varying degrees of supplier power depending on their
product line. Overall, supplier power doesn’t negatively affect potential profitability.
While the differences in product offerings might be few and switching costs inconsequential,
brand identity often drives customer loyalty. Firms that are successful in this industry find a
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The GAP, Inc. Case
market niche and create a brand or product to meet the needs of the niche market. Armed with a
recognized and accepted brand, the firm fends off the threat of substitutes by furthering defining
itself as either a cost leader or a product differentiator.
Other characteristics of the specialty retailing industry include:
- Focused product line (clothing type, age segment, fashion orientation)
- Large number of branded retailers
- Sell an intangible. Stores offer customers an opportunity to conform, differentiate
themselves.
- Typically found in malls. Rely on spillover traffic from anchor stores
The characteristics of the specialty retailing industry that determine its profit potential also make
it difficult to earn abnormally high profits. A high degree of competition and availability of
substitutes force firms to keep prices low to remain competitive. In spite of the need to offer
competitive prices, the firms must ensure that they are earning a large enough profit to cover the
expenses associated with creating and marketing fresh, new designs. The difficulty associated
with earning high profits in this industry lies with the complexity of margin and asset
management.
Table I – Specialty Retailers Industry Composite
Profit margin
ROE
Fiscal 1991
5.3%
19.6%
Fiscal 1990
5.7%
21.1%
Fiscal 1989
6.0%
22.6%
Fiscal 1988
6.1%
23.0%
2. Describe the Gaps business strategy, and how it might allow the Gap to earn higher returns
on investment than others in the industry?
The Gap’s simple, yet effective, product strategy has enabled it to achieve a brand identity that,
when combined with its existing operational efficiencies, allow it to earn higher returns on
investments than other specialty retailers.
The first Gap opened in 1969 in San Francisco, selling Levi jeans and records.
In the 20-year
span of 1969 to 1990, Gap has reinvented itself numerous times to ensure the firm excels at
meeting the demands of a wide range of customers. The firm’s ability to continuously reinvent
itself is a key component of its track record of achieving abnormal earnings.
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The GAP, Inc. Case
In 1991, amidst a recession, Gap produced a stunning ROE of approximately 40%. By this
time, the firm had established itself as a “trend-setter in casual wear, at good prices, for younger
consumers.” The company focuses on providing “good style, good quality, and good value.”
The Gap product line, mostly staple/commodity apparel, ensures that there will always be a high
demand for their products in spite of other competitors or changing consumer moods. These
staple items comprise a relatively limited s.k.u. count which makes inventory management easy
relative to large s.k.u. retailers. Fashion trends at this time undoubtedly worked to Gaps
advantage and greatly boosted its sales. The move away from pretentious brands in the 1980’s
to a more modest style of clothing positioned Gap as the go-to source for casual clothing.
One of the many challenges of the retail industry is to predict fashion trends a year of more in
advance. Retailers must make huge bets on what will sell far advance. All retailers are
vulnerable to rapidly changing fashion demands. Gap combats inventory risk via several
strategies. First, the firm maintains tight controls of accounting, purchasing, and marketing
functions. Gaps investments in infrastructure over the years allow it to replace stock with
maximum speed. The Gap’s product and promotion strategies have supported the adoption of
operationally efficient product and inventory processes. Since The Gap concentrates on offering
mostly commodity products with modest design variations, the company can spend little time
and money test marketing their new designs. This shortened market test period helps to keep
expenses low, margins high, better match supply to demand. To sum, Gap achieves higher
returns than the industry partially because of its superior processes and management.
Finally, Gap excels at managing and leveraging its brand. The introduction and promotion of
GapKids and BabyGap allows the company to extend its product line to new market segments
with relatively few design and/or product changes. Gap recognized in the late 1980’s that their
traditional customers were aging. Management’s vision to open GapKids and BabyGap to
appeal to the children of their original customers is evidence of the firm’s desire to provide a
total solution to all age segments.
3. Is there anything unusual about the Gap's accounting that could explain its abnormally high
return on equity for 1991?
The Gap’s accounting practices were reviewed to determine if they could explain the abnormally
high return on equity enjoyed by The Gap during 1991. Available data from 1990 and 1991
were applied to the Beneish model to determine if The Gap was manipulating its earnings (See
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The GAP, Inc. Case
appendix for results.) Although all of the data needed for the Beneish model was not provided
in the case, the available results of the analysis revealed that The Gap was not manipulating its
earnings. In fact, The Gap’s probability for manipulation is 97 percent lower than the average
probability of manipulation for the designated control firms -- .025% for The Gap versus 1.1%
for the control firms. The Gap did have a substantially higher leverage ratio than both the
control firms and the GAAP violators. This elevated leverage ratio is a direct result of The
Gap’s borrowing practices between 1990 and 1991 and does not indicate earnings manipulations.
During this time frame, The Gap increased its long-term liabilities by 1,450 percent -- $5 million
to $77.5 million.
Since The Gap’s abnormally high return on equity could not be explained by questionable
accounting practices, The Gap’s financial statements were reviewed to determine if another
explanation existed. The financial statements for 1990 and 1991 revealed that The Gap has
almost exclusively financed its growth through debt rather than equity financing. Between 1990
and 1991, The Gap increased its total long-term liabilities by 192.5 percent while its equity
activity remained virtually flat. Bolstered by additional store openings and leasehold
improvements, The Gap’s sales increased at a substantially faster rate than its equity ownership.
Since equity and not liability is a key component of the return on equity ratio, their return on
equity performance would indicate that The Gap’s management and brand have achieved a level
of profitability and efficiency that may not fully exist. This analysis indicates that the firm’s
abnormally high return on equity is not the result of unusual accounting practices but rather the
result of management decision-making.
4. Decompose the Gap's return on equity for 1991, using the Du Pont formula. Compare the
results with those of the Limited, the specialty retailing industry, and the Gaps' prior
experience. What components of profitability account for the Gap's advantage over others.
What underlying economic story might explain the advantages?
Between fiscal 1990 and 1991, The Gap experienced significant revenue growth, 30.3 percent.
This strong revenue growth doubled the average sales growth, 15.1 percent, experienced in the
specialty retailing industry. Outshining this impressive sales growth was an abnormally high
ROE of 40.2 percent. While sales certainly had a positive impact on The Gap’s ROE, other
drivers of profitability, both financial and strategic, can be used to explain the firm’s returns.
Application of the Du Pont approach reveals the specific drivers impacting the abnormally high
ROE.
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The GAP, Inc. Case
Level I: ROE
Initially, return on equity (ROE) will be examined. ROE is a comprehensive indicator of the
firm’s performance because it provides an indication of how well the company manages funds
invested by shareholders. Between fiscal 1990 and 1991, The Gap’s ROE increased by 11.8
percent during a time when the overall retail industry was in decline. The Gap’s ROE increased
from 35.96 percent to 40.2 percent exhibiting performance that was abnormally high for any
company, particularly one associated with an industry in decline. During this same time period,
the ROE of a composite of specialty retailers, The Gap’s competitors, fell by 7.11 percent to 19.6
percent. A direct competitor of The Gap, The Limited, experienced an even sharper decline in
ROE, falling 17.5 percent to 23.5 percent. Although The Limited and the composite specialty
retailers exhibited ROE’s higher than that of average firms (10 to 15 percent), they were unable
to sustain the returns experienced by The Gap. The Gap's ROE, while bolstered by efficient
operations and asset management, can be attributed to The Gap’s strong brand name and target
marketing strategy.
Level II: Profitability, Activity & Solvency
Examination of the positive drivers of ROE leads to an analysis of The Gap’s profitability,
activity, and solvency. Profitability, also known as return on sales, measures the amount of
profit gained for every dollar of revenue that is earned. Activity, also known as asset turnover,
measures the organization’s ability to efficiently employ resources. Solvency, also known as
financial leverage, indicates the degree to which the company’s assets are internally financed.
The Gap’s profitability, activity, and solvency measures for fiscal 1990 and 1991 follow:
Table II – Du Pont Analysis
Fiscal Year
1990
1991
Percent Change
Profitability
7.47
9.13
22.2%
Activity
2.85
2.62
-8.07%
Solvency
1.69
1.68
-0.59%
The increase in profitability between 1990 and 1991 had a direct, positive impact on ROE.
Sales increased by 30.3 percent while expenses as a percent of sales decrease. The Gap's
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The GAP, Inc. Case
performance far exceeded the profitability results of The Limited, who experienced a 13.42
percent decline in profitability, and the industry composite, who experienced only a 2.12 percent
increase in profitability. Although the three firms/composites experienced growth in sales
during fiscal 1991, The Gap appears to be the only firm that was able to manage its expenses
during this growth. The Gap appeared to lose some asset management efficiencies as evidenced
by the slight reduction in their activity ratio. The rapid store expansion and remodeling efforts
could attribute for this reduction as the firm moves into new markets where logistical and
inventory issues may have developed. The Limited too experienced a modest decline in its asset
turnover ratio, while the industry composite showed a 7.0 percent improvement in its efficiency
levels. The Gap's solvency ratio reflects a nearly immeasurable reduction in 1991, .59 percent.
The maintenance of a fairly steady ratio accurately reflects the lack of significant changes in
equity financing during the fiscal year. With a ratio exceeding 1.0, The Gap continues to appear
to finance much of its debt through external financing. The Limited and the industry, while
experiencing slight declines in their solvency ratios, continue to appear to receive much of their
capital through external, debt financing.
Level III: Drivers of Profitability, Activity & Solvency
Exhibit 2 illustrates the changes occurring between 1990 and 1991 for the drivers of profitability,
activity, and solvency. Analysis of these drivers further explains the importance and power of
The Gap brand to its ROE.
Drivers of profitability include those factors that impact the relationship between sales and net
income. These factors include cost of goods sold, gross profit margin, selling, general and
administrative (SG&A) expenses, operating income, and pre-tax income. In Fiscal 1991, The
Gap experienced positive changes in all of the factors affecting profitability. Both cost of goods
sold and selling, general, and administrative expenses as a percent of sales decreased by nearly
3.0 percent. This reduction reveals some production and operational economies of scale that
The Gap enjoyed as a result of its expansion. Since the firm's relative expenses were falling,
gross margin, operating income, and pre-tax income as a percent of sales increased by 5.31,
20.63, and 20.16 percent respectively. While The Gap enjoyed positive gains in each of its
profitability drivers, The Limited experienced some expense management issues. Between
fiscal 1990 and 1991, The Limited saw nearly a 3.0 percent gain in its cost of goods sold expense
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The GAP, Inc. Case
as a percent of sales. The industry too saw a modest increase of .35 percent. These increases
indicate that The Limited and the industry composite retailers are experiencing increasing costs
of producing their products. Impacted by rising costs, the gross profit margins for these
firms/composites fell.
While these profitability drivers would predict a positive return for The Gap in 1991, they do not
reveal the specific competitive advantage that The Gap enjoys. Although growth or decline
trends differ, there are few significant differences in the expense to sales relationships (on a
percentage basis) experienced by The Gap, The Limited, and the industry (see Exhibit 2). To
answer the question of why and how The Gap is so profitable, examination of the store sales is
required. In 1991, The Gap earned $481 per square foot in their stores. This value represented
a 9.82 percent increase over 1990's performance. Compared to the $309 per square foot earned
by The Limited in 1991, The Gap appears to be a significantly more profitable and popular store.
The popularity of The Gap has not been created by extensive advertising, for The Gap spent
nearly $1.2 million less on advertising in 1991 than did The Limited. The explanation for this
popularity can only be defined by the real competitive advantage enjoyed by The Gap brand
name.
Examination of the asset turnover measures reveals some improvement and some decline in The
Gap's asset management techniques. The Gap's accounts receivable turnover increased by 15.7
percent indicating quicker collection times and potentially more aggressive collections policies.
The Gap experienced a 10.70 percent growth in its inventory turnover indicating strong
inventory management and efficiencies. Additionally during 1991, The Gap was able to
increase their accounts payable turnover by .42 percent offering them greater and longer access
to their funds. Declines in asset management performance were experienced in The Gap's
property, plant and equipment turnover and days' inventory ratio, 12.90 and 9.72 percent declines
respectively. These declines could be a result of the rapid store expansion and improvement
projects undertaken by the firm in 1991. The Limited and the industry composite retailers
experienced similar declines in property, plant, and equipment turnover. While The Limited
declined by 3.74 percent, this decline was related to a 3 percent store growth rate versus a 13
percent growth rate for The Gap stores.
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The GAP, Inc. Case
Examination of the liquidity ratios reveals that The Gap is both flush with cash and external debt.
Between 1990 and 1991, The Gap’s cash and marketable securities increased by 188 percent or
8.0 percent of sales. The firm’s cash position enabled them to achieve a 3.63 percent increase in
their operating cash flow ratio. The Gap’s current ratio increased by 23.02 percent to 1.71.
The increase in this ratio provides further proof of The Gap’s positive cash position and strong
ability to cover its liabilities with current assets. This strong position could also be seen in the
positive increase in the quick ratio.
Examination of the firm’s solvency ratios provide great insight into how The Gap achieved such
a high ROE in 1991. Between 1990 and 1991, the firm financed virtually all of its growth with
external debt, and there was little change in the company’s equity position. The company’s
financing decisions are clearly reflected in the long-term debt to stockholder’s equity ratio. This
ratio increased by 968.22 percent, 1.07 to 11.43 percent year over year. While the company’s
interest coverage ratio still indicates a strong ability by the company to cover its interest
payments, this ratio fell by 36.03 in 1991. Overall, The Gap’s solvency and liquidity ratios
point to a firm that is financially strong with the capital resources needed to grow and retain
competitive advantage in the specialty retailing industry.
5. Based on your answer to the prior question, list the key components of profitability that give
the Gap its advantage in 1991. Discuss how likely it is that the advantages can be sustained
in the future.
Analysis of The Gap’s ROE and drivers of profitability, asset turnover, and solvency reveal
several key components of profitability that gave The Gap competitive advantage in 1991.
These advantages which included strong sales growth and efficient expense management, were
overshadowed by the benefits of its powerful, recognizable, and desired brand name.
The Gap’s strategy for selecting and serving its target niche market enabled it to position itself as
a product differentiator in the competitive specialty retailing industry. It is expected that The
Gap brand name will enable the company to sustain a competitive advantage in the future. This
forecast is supported by the 15.46 percent increase in the company’s sustainable growth rate as
compared to the decrease of both The Limited and composite industry’s rates. While
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The GAP, Inc. Case
competitors may introduce substitute products into the market, they will be unable to undermine
The Gap’s competitive advantage in the short-term. While consumer tastes may change in the
future, it is expected that The Gap’s commodity-style products will, with continuous minor
modifications, continue to appeal to their target market – young to middle age adults, married
and unmarried, with and without kids.
6. Assume that the Gap maintained asset turnover and financial leverage to the levels of 1992.
How low could net profit margin fall while still generating a return on equity in a normal
range of (say) 15 percent? If the Gap's ROE followed the usual path taken by firms with
high ROE, how long would it take for the Gap's profit margin to fall to this level? What
reasons are there to believe the Gap's ROE might remain abnormally high?
Return on Equity is defined as the product of asset turnover (Sales/Assets), profit margin (net
income/sales), and financial leverage (assets/equity). In 1992, the asset turnover ratio was 2.62
and the financial leverage ratio was 1.66. Solving for profit margin, the lowest The Gap’s profit
margin could fall while still generating a 15 percent "normal" ROE would be 3.4 percent.
If The Gap’s ROE followed the usual path taken by firms with high ROE, The Gap’s profit
margin would drop to the "normal" level in five to ten years. It may experience some erosion of
ROE with the new entry of competitors copying The Gap model, but it seems that it should be
able to sustain a higher than normal ROE over the longer term. The combination of The Gap’s
strong brand identity ("good style, good quality, and good value") and its efficient business
model would be difficult to surpass. It is both a cost leader and a product differentiator. Its
simple brand identity and operational efficiencies enable The Gap to sell its high demand
non-cyclical "staple" products at reasonably low prices and yet garner high margins from its
target market. The Gap’s scale economies, effective cost management practices, and strong
financial position should discourage direct competition, because it is extremely capable of
lowering prices and leveraging its strong brand position to thwart competition. Potential new
entrants therefore may not think they can compete effectively with The Gap, so they may view
other opportunities as more lucrative. There will probably only be a few firms with the resources
and know-how who will try to compete, but since there are only a relative few, an oligopolistic
situation would probably exist, which by definition should yield a higher than normal ROE.
Question 6.
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The GAP, Inc. Case
7. Forecast sales, expenses, and earnings for 1992, describing your key assumptions along the
way. How does your forecast compare to management’s goal of 10.5 percent to 11 percent
pre-tax profit margin?
Sales Estimates
Two methods were employed to estimate future sales. The first method was simply to calculate
percent increases in sales for the last few years. The sales increases in the last four years were
30%, 22%, 27%, and 18%, respectively. Given that The Gap was so successful in 1991,
achieving nearly 40% ROE, The Gap will likely face greater competitive pressures in the coming
year from other retailers who wish to duplicate The Gap’s results. It would probably be prudent
therefore to estimate next years sales increase conservatively. A conservative estimate of the rate
of sales increase would be 23%. Increasing FY 1991 sales by 23 percent would yield FY 1992
sales of roughly $3,009,000,000.
Another means of estimating next year’s sales involves looking at The Gap’s physical data. The
Gap states in its annual report that it will add 135 new stores and expand approximately 100
stores. It also states that it currently operates 1,216 stores. It also provides sales per square foot
estimates as well as comparable store growth figures. In 1991, sales per square foot were $481.
Dividing FY 1991 total sales by this sales per square foot figure ($481) yields an estimate of
total square footage in all of its stores. Dividing this total square footage by the number of stores
(1216) yields an average 4307 square feet per store. The annual report also indicates that its
newer stores are as large as 7000 square feet.
With this information, one can conservatively assume that new stores will be roughly 6000
square feet, expanded stores will increase their size by 1000 square feet, and existing store sales
growth will be marginal in a market with heightened competition. Using these assumptions, with
no sales increases in existing stores, one could estimate sales figures as follows:
6000 sq ft
ft
1000 sq ft
4307 sq ft
ft
x
135
New stores in 1992
x
x
100
1216
Expanding stores in 1992
Existing stores (end of 1991)
=
=
Total square feet in 1992
=
10
=
810000
sq
100000
sq ft
5237312 sq
6147312
sq ft
The GAP, Inc. Case
6137312 sq ft
Sales Estimate
x
$481/sq ft
=
$2,956,857,072 =
FY 1992
In 1991, existing stores increased their sales by 13 percent. A conservative marginal increase of
3 percent, reflective of expections of increased competition, would yield $76,000,000 in
additional revenue.
Both estimates, while somewhat subjective, support one another, suggesting 1992 sales of
slightly in excess of $3 billion dollars.
Other Assumptions
Cost of goods sold is estimated as a percent of sales. In Fiscal years, 1991, 1990, and 1989,
COGS/Sales was 62.3 percent, 64.2 percent, and 65.9 percent respectively. Cost of goods sold
was conservatively estimated as 63 percent of Sales.
Selling and administrative expenses also generally follow sales increases, so selling and
administrative expenses were also estimated as a percentage of sales. Between 1991 and 1988,
selling and administrative expenses to sales ranged from 22 to 24 percent. Selling and
administrative expenses were conservatively estimated at 23 percent of sales.
The interest rate on long-term debt is 8.87 percent. Since it is the only rate, it is the interest rate
that we will use on all debt.
The income tax rate is 38 percent of pre-tax income.
Dividends are projected to grow at 20 percent per year.
Given these assumptions, 1992 pretax income was $430,000,000. This equated to roughly 14
percent pre-tax income. So, it surpassed management’s goal of 10.5 to 11 percent growth.
See Proforma Income Statement in Appendix.
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The GAP, Inc. Case
8.
Forecast sales, expenses, and earnings for 1992, describing your key assumptions along the
way. How does your forecast compare to management’s goal of 10.5 percent to 11 percent
pre-tax profit margin?
The next step is to create proforma balance sheets. Again, these balance sheets require that one
make assumptions of the various balance sheet items.
Cash is estimated in the cash flow statement once all balance sheet items are estimated. It is a
plug figure.
Accounts Receivable is estimated as .3 percent of sales.
Inventory is estimated based on the projections of Cost of Goods Sold. Essentially, COGS is
divided by the inventory turnover. Inventory turnover was conservatively estimated at 4.9.
Other Assets which include Prepaid Expenses are estimated to grow at the rate of sales.
Property, plant, and equipment are estimated to grow at the rate of sales, net of depreciation.
Accounts payable is estimated by dividing merchandise purchases by the A/P turnover number
of 12.
Other Current and Non-current liabilities are estimated to grow at the rate of sales.
Long-term debt is estimated to increase by 10 percent of capital expenditures.
Capital Expenditures and Depreciation are estimated to grow at the rate of sales.
Dividends are estimated to grow at a rate of 8 percent.
Please see the Proforma Balance Sheet in the Appendix.
9. Using your forecasts of income statement and balance sheet accounts, create a forecast of
1992 cash from operations, net of investment in working capital and plant. Prepare the
forecast on a pre-interest basis, so that it represents cash flow available to debt and equity
holders.
See Pro Forma Cash Flow Statement in Appendix.
10. Based on the information in the case and the discussion in the text, estimate the cost of debt
and equity capital.
See Weighted Average Cost of Capital in Appendix.
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The GAP, Inc. Case
11. Extend your forecast of earnings and cash flows for five or ten years, and apply the DCF
technique to estimate The Gap’s value.
Using assumptions of Sales growth of 20 percent, COGS/Sales of 63 percent, and GSA/Sales of
23%, we estimate the value of to be $2.045 billion or $13.84 / share using the DCF method.
See FCF Valuation in Appendix.
12. Alternatively, extend your forecast of earnings and the book value of equity for five or ten
years, and apply the discount abnormal earnings technique to estimate The Gap’s value.
Using these same conservative assumptions, Sales growth of 20 percent, COGS/Sales of 63
percent, and GSA/Sales of 23%, we estimate the value of to be $2.526 billion or $17.72 / share.
See Abnormal Earnings Valuation in the Appendix.
13. Compare your estimate of value from above to market price of $55/share. What changes in
assumptions would be needed to produce an estimate equal to market price?
To produce a $55/share price, one must increase sales growth to 30 percent and decrease COGS/Sales to roughly 59
percent. This would produce an valuation of $55.80/share using the abnormal earnings valuation method and $61
using the DCF method.
14. Evaluate the assumptions necessary to support a market price of $55/share. Are they more or
less optimistic than your forecast? Are they more or less optimistic than management’s
goals?
The assumptions of 30 percent sales growth and COGS/Sales of 59 percent do not appear to be
sustainable in light of the likelihood of heightened competition. It seems more likely that sales
growth will be more in line with Gap management’s goal of 20 percent sales growth. It appears
that cost of goods sold was misstated on one of the statement of earnings in the case and
therefore it was more along the lines of 62.3 percent as opposed to the 60 percent detailed in one
of the income statements. It appears to relate to occupancy expenses being included and then not
included in COGS numbers.
Management’s goal is to achieve 30 percent ROE. With the 20 percent sales growth and 63
percent COGS, ROE is estimated at 29 percent in 1992, so it would not meet management’s
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The GAP, Inc. Case
expectations. The 13.8 percent pretax margins would however meet management expectations of
10.5 percent.
15. Based on your work, would you recommend The Gap’s stock to an investor in early 1992?
It does not appear to be a wise move to purchase Gap stock at $55/share. With conservative
assumptions, it does not appear to be worth $55. If one feels that Gap will not be adversely
impacted by heightened competition, then perhaps it is worth $55/share. Perhaps the valuation of
less than $20 is conservative, but given the conditions it appears warranted.
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