The Gap Inc. (GPS) is a leading apparel specialty retailer that sells casual apparel for men, women, and children under the Gap, Old Navy, Banana Republic, Piperlime and Athleta brands. With a very broad spectrum of consumers, the company becomes the largest specialty apparel retailer in the U.S. Additionally, the company plans to open five Old Navy brand stores in China this year, so the focus in international markets is a driver for future revenues. The firm's competitors include American Eagle Outfitters Inc. (AEO) and The TJX Companies Inc. (TJX).
Now, turning our attention to the future direction of the stock, let's take a look at the intrinsic value of this company and try to explain to investors the reasons why it is a good buy or not. In this article, we present a model that is by no means the be-all and end-all for valuation. The purpose is to force investors to evaluate different assumptions about growth and future prospects.
Valuation
In stock valuation models, dividend discount models (DDM) define cash flow as the dividends to be received by the shareholders. Extending the period indefinitely, the fundamental value of the stock is the present value of an infinite stream of dividends according to John Burr Williams.
Although this is theoretically correct, it requires forecasting dividends for many periods, so we can use some growth models like: Gordon (constant) growth model, the Two or Three stage growth model or the H-Model (which is a special case of a two-stage model).
To start with, the Gordon Growth Model (GGM) assumes that dividends increase at a constant rate indefinitely.
Let´s estimate the inputs for modeling:
Required Rate of Return (r)
The capital asset pricing model (CAPM) estimates the required return on equity using the following formula: required return on stockj = risk-free rate + beta of j x equity risk premium
Assumptions:
Risk-Free Rate: Rate of return on LT Government Debt: RF = 2.67%
Beta: β =1.47
GGM equity risk premium = (1-year forecasted dividend yield on market index) +(consensus long-term earnings growth rate) – (long-term government bond yield) = 2.13% + 11.97% - 2.67% = 11.43%[1]
rGPS = RF + βGPS [GGM ERP]
= 2.67% + 1.47 [11.43%]
= 19.47%
Dividend growth rate (g)
The sustainable growth rate is the rate at which earnings and dividends can grow indefinitely assuming that the firm´s debt-to-equity ratio is unchanged and it doesn´t issue new equity.
g = b x ROE
b = retention rate
ROE can be estimated using Dupont formula:
Because for most companies, the GGM is unrealistic, let´s consider the H-Model which assumes a growth rate that starts high and then declines linearly over the high growth stage, until it reverts to the long-run rate. A smoother transition to the mature phase growth rate that is more realistic.
Dividend growth rate (g) implied by Gordon growth model (long-run rate)
With the GGM formula and simple math:
The growth rates are:
| Year | Value | g(t) |
| 1 | g(1) | 23.53% |
| 2 | g(2) | 21.92% |
| 3 | g(3) | 20.31% |
| 4 | g(4) | 18.70% |
| 5 | g(5) | 17.09% |
G(2), g(3) and g(4) are calculated using linear interpolation between g(1) and g(5).
Calculation of Intrinsic Value
| Year | Concept | Amount | Present value |
| 0 | Div 0 | 0.88 | |
| 1 | Div 1 | 1.09 | 0.91 |
| 2 | Div 2 | 1.33 | 0.93 |
| 3 | Div 3 | 1.59 | 0.94 |
| 4 | Div 4 | 1.89 | 0.93 |
| 5 | Div 5 | 2.22 | 0.91 |
| 5 | Terminal Value | 108.93 | 44.75 |
| Intrinsic value | | | 49.36 |
| Current share price | | | 43.25 |
Final Comment
When the stock price is lower than the intrinsic value, the stock is said to be undervalued and it makes sense to buy the stock. We have covered just one valuation method and investors should not be relied on alone in order to determine a fair (over/under) value for a potential investment.
Hedge fund gurus have also been active in the company. Gurus like Paul Tudor Jones (Trades, Portfolio), Louis Moore Bacon (Trades, Portfolio), Chase Coleman (Trades, Portfolio), Murray Stahl (Trades, Portfolio) and Edward Lampert (Trades, Portfolio) have invested in it in fourth quarter 2013.
Disclosure: Victor Selva holds no position in any stocks mentioned.
[1] This values where obtained from Blommberg´s CRP function.
Also check out: Chase Coleman Undervalued Stocks Chase Coleman Top Growth Companies Chase Coleman High Yield stocks, and Stocks that Chase Coleman keeps buying Edward Lampert Undervalued Stocks Edward Lampert Top Growth Companies Edward Lampert High Yield stocks, and Stocks that Edward Lampert keeps buying
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GPS STOCK PRICE CHART
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By comparison, at today's mortgage rates of 3.5%, you'd only pay $106,000 over the life of the loan. That is crazy... As regular readers know, I have been extremely optimistic on U.S. housing – more so than any other major analyst on the planet. The market has been roaring back recently. The official statistics of home prices are always MONTHS old. But median existing home prices are up 12% over the most recent 12-month period (February 2012-February 2013). That's the largest 12-month increase we've seen since late 2005... near the top of the housing bubble. And the big boom is happening right this second. We now have tons of buyers and not much supply. The downside of this situation is you're not going to find the same amazing deals you would have a year ago. The upside of this situation is Economics 101: With no supply and tons of demand, housing prices will continue to rocket higher. Folks at the conference shared their frustrations with me. They feel like they've missed it... that they can't get the great deal anymore. What most people don't realize is that MARKET PRICE today is still a fantastic deal... Most people don't understand compound interest and fair value. So most people today will back down... They won't pay full price or more because they don't really understand where we are now in housing. In the grand scheme of things, full price today is still cheap. It takes a long time for house prices to reach fair value... They can't jump overnight like stock prices. Housing is still incredibly affordable thanks to low mortgage rates. Coupled with no supply and tons of demand, we have a recipe for much higher housing prices in the next couple years. Yes, it's now much harder to get a good property dramatically below asking price. But buying at MARKET PRICE is still a bargain today. I am confident that you will look back on today's prices in two years and wonder why the heck you didn't ACT. The market has changed... but don't worry so much. Housing is in a new bull market. And it is just the beginning... Our uptrend is finally here. And it could last for a few years... at least. Good investing, Steve 
On Monday, the affordable-housing nonprofit NLIHC released a study about how much money it takes to rent a market-rate apartment in the U.S. The results were dismal. The average American renter earns $14.64 an hour, according to the study. But on average it takes $18.92 an hour for a worker to pay for a two-bedroom house or apartment rental. That's a 52% increase since 2000. The average worker fares poorly in light of this study. But the minimum-wage worker is worse off by far. Minimum wage is $7.25, although Congressional Democrats are seeking to raise that to $10.10. The NLIHC found that by pooling their resources, two minimum-wage workers still wouldn't be able to afford a two-bedroom rental on their own. Even with the proposed minimum-wage increase, a single worker couldn't afford a one-bedroom alone, except in Arkansas, Kentucky or Puerto Rico. More than 40 million Americans rent, or about 35% of American households. 25% of renters have extremely low income. According to Sheila Crowley, the president of the NLIHC, "Three out of four extremely low income households have to spend more than half of their income on housing costs." So why does the Case-Shiller Housing Index show a slight drop in prices? That seems to suggest that inflation is under control and that prices are stable. And yet rents are up. It's less mysterious than it seems, said Claudia Coulton, Distinguished University Professor at Case Western Reserve University and co-director of the Center on Urban Poverty and Community Development there. Coulton said, "The single family home market, which is what Case-Shiller indexes, is still soft following the foreclosure crisis and tight credit situation. There are too many homes on the market in many regions along with too few qualified buyers." So the home sales market is languishing. If people can't afford to buy, what then? "Many of those individuals, who may have been home owners or first time buyers before in past years, are now flooding the rental market, making supplies tight," Coulton said. "Rental property owners are taking advantage of the situation to get increased rents. For low income households, this problem is unlikely to change much in the short run unless there is an increase in housing subsidy or low income rental housing programs." There is a disconnect between home ownership and renting in terms of affordability. Renters can't afford to buy, and the glut of renters has driven prices up drastically. Yet employment and wages have stagnated. Follow @NoTicker 
Why Bitcoin will recover from Mt.Gox 
Alamy We Americans love independence and freedom of choice, believing them essential to our well-being. Yet more choice is not, it turns out, leading to more happiness or success. I believe fewer, better choices for individual investors are what we need. Research shows that a certain amount of autonomy around choice is required to achieve a basic level of happiness. However, after that certain point, more choice actually detracts from personal happiness. Too many choices result in feeling overwhelmed, often leading to the inability to make a decision. Information overload, a term popularized by Alvin Toffler in his 1970 book "Future Shock," takes place when the advantages of diversity and individualization are canceled by the complexity of a buyer's decision-making process. On the surface, it would appear that having more choice is a positive development. However, this hides an underlying problem: When faced with too many options, people have trouble determining the best choice and, as a result, can remain indecisive, unhappy and immobilized. Established finance theory has assumed that investors have little difficulty making financial decisions and are well informed, thoughtful and consistent. It's also assumed that investors are not confused by how information is presented and are not influenced by emotions. Clearly, reality does not match this theory. Behavioral finance, on the other hand, is the study of the psychology of financial decision-making and has led to great insights on how investors actually make decisions. Investors confused or uncertain about how to proceed become immobilized. When too many choices are available, inertia sets in. People fail to take action, even on things they want or have agreed to do. This inertia can act as a barrier to effective financial planning, stopping people from saving and making reasonable allocation decisions and necessary changes to their portfolios. The financial services industry is not necessarily helping investors by devising more investment options. There are currently tens of thousands of mutual funds, variable annuity and 401(k) subaccounts, and exchange-traded funds -- not to mention thousands of individual stocks and bonds and a plethora of "alternative" investments. We've got 401(k) plans with dozens of investment options. People make better decisions with a reasonable or limited number of investment options and the "right" amount and type of information about each of them. The need for diversification is one reason we're offered choices in our 401(k) plans. Investors may understand the importance of diversification, but not knowing how to achieve it, they simply adopt what we commonly call "naive diversification," or the "1/n" approach. Without better understanding, plan participants often simply allocate their funds equally across the range of options provided. For example, I've seen investors allocate 25 percent into each of four "lifestyle" funds, only to end up with the exact same allocation they'd have had if they'd selected the balanced option to begin with. But the effort lent the illusion of diversification. I argue that 20 or so investment options are more than enough to achieve proper diversification. In her book, "The Art of Choosing," Columbia University professor Sheena Iyengar shares a study of shoppers who are given an array of either 24 or only six different flavors of jam to select from. The research showed that "fantastic variety seems to favor browsers over buyers." More people spent time exploring the 24 flavors, but when it came to purchasing jam, the booth displaying just six options enjoyed far more sales. Given fewer choices, people felt they could make an informed decision and complete a purchase. Psychologist Barry Schwartz argues in his book, "The Paradox of Choice: Why More Is Less," that eliminating consumer choices can greatly reduce anxiety for shoppers. Reducing anxiety for investors should increase savings rates and confidence around decisions taken. The recent Dodd-Frank Act included provisions requiring that those who render financial advice to retail investors be held to a fiduciary standard no less strict than that of the Advisors' Act of 1940, which requires all financial advisers to put clients' best interests ahead of their own.