Yahoo Finance Does The Gap, Inc.'s (NYSE:GPS) P/E Ratio Signal A Buying Opportunity?
This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how The Gap, Inc.'s (NYSE:GPS) P/E ratio could help you assess the value on offer. Based on the last twelve months, Gap's P/E ratio is 8.25. That corresponds to an earnings yield of approximately 12.1%.
Check out our latest analysis for Gap
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Gap:
P/E of 8.25 = $17.73 ÷ $2.15 (Based on the trailing twelve months to November 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.
How Does Gap's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (16.5) for companies in the specialty retail industry is higher than Gap's P/E.
Gap's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Gap, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Gap saw earnings per share decrease by 11% last year. But it has grown its earnings per share by 8.5% per year over the last three years. And over the longer term (5 years) earnings per share have decreased 5.4% annually. This growth rate might warrant a below average P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
How Does Gap's Debt Impact Its P/E Ratio?
Gap has net debt worth just 2.6% of its market capitalization. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.
The Verdict On Gap's P/E Ratio
Gap's P/E is 8.3 which is below average (18.8) in the US market. The debt levels are not a major concern, but the lack of EPS growth is likely weighing on sentiment.
Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
