Gap Bull's Pen
by Yi-Hsin Chang ([email protected])

Different investors have different criteria for picking stocks. Some look first at a stock's historical price performance. Others pore over spreadsheets to evaluate a company's record of revenue and earnings growth. Then there are others who are drawn simply by a great story, a great name that instantly gives them a good gut feeling that they've got a winner. Gap Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GPS)") else Response.Write("(NYSE: GPS)") end if %> is a company that measures up no matter which way you look at it. Frankly, I have no idea how Louis, my worthy adversary and fellow alumnus, plans to make an argument against this great company.

Take a look at Gap's stock performance for the past three months, six months, and year by clicking on each of the corresponding Web links. In the past year, Gap's share price has shot up more than 156% to $66 5/8 from $26 (split-adjusted). In the last three years, the stock has rocketed up 483% from $11 7/16. Now check out Gap's performance versus the S&P 500 for the past three months, six months, year, and three years. No question about it, in each of these charts, the graph of Gap's price movement makes the one for the S&P 500 look almost flat. Its impressive stock performance made Gap a Daily Double in late June.

As for Gap's record of revenue and earnings growth, last year the company reported a 23% increase in sales to $6.5 billion from $5.3 billion and an 18% rise in net profits to $534 million from $453 million. Such growth numbers aren't exclusive to 1997. For the last three years, sales grew at a compound annual growth rate of 21% while earnings rose 19%, despite the volatility of the retail market. Even looking back a whole decade, Gap was able to deliver compound sales growth of 20% a year and earnings growth of 23%.

All this number crunching leads us to the story behind this company and what makes it such a stunning success. First off, I have yet to describe what Gap Inc. does, and yet even before you read the introduction to this Duel, you knew what The Gap was the second you saw the snappy name. That's because in 29 years Gap has grown from a single clothing store in San Francisco named after "the generation gap" to a massive international chain of around 2,200 stores selling a wide range of casual apparel, personal care products, and accessories for men, women, and kids of all ages.

Gap, which also operates GapKids and babyGap, is arguably as established a brand in retail as Coca-Cola and McDonald's are in their respective fields. What's more, Gap also has been able to establish new brands and new stores without cannibalizing its core brand and business. GapKids and babyGap broadened Gap's customer base by making it possible to wear Gap from babyhood through adulthood. Banana Republic fills the gap between a suit and jeans and a T-shirt, while Gap's newest -- and fastest growing -- addition, Old Navy, offers "value-priced" family apparel (for example, jeans for around $20) in a decidedly different warehouse environment. Old Navy surpassed the $1 billion sales mark in less then four years of operation, pretty much unheard of in this line of business.

But far from resting on its laurels, Gap continues to expand and develop its brands at a rapid rate. Last year, the company spent upwards of $160 million, or roughly 2.5% of sales (0.8 percentage points more than the year before), on a more aggressive advertising campaign. It also launched an online store for Gap clothes. This year, the company plans to up the ante and spend more than $300 million, 4% of sales, on advertising. In April, the company kicked off a global campaign promoting Gap khakis. Meanwhile, Old Navy has been spreading the word through campy TV ads featuring the likes of Joan Collins and Morgan Fairchild. This year, Gap plans to open another 300 to 350 stores worldwide, including 45 to 50 outside the U.S.

The compelling story behind the Gap is precisely the reason why Tom Gardner essentially admitted his mistake in selling the stock from the Fool Portfolio two summers ago and why the Cash-King Portfolio announced that it would buy $1,875 in Gap shares in late April. It's also likely why Berkshire Hathaway's car insurance unit, GEICO Corp., acquired 125,000 shares in the company early last year.

Now skeptics like Louis may say that Gap's stock is overvalued. The Fool Portfolio actually sold the stock based on short-term valuation concerns two years ago, but Cash-King recently bought it back, calling it a "very Foolishly run business that has consistently provided great returns to its shareholders." Certainly, we may all wish we had picked up a shopping bag full of Gap shares a few months or a few years back, but based on the company's strong fundamentals and solid business plan, I say it's safe to go with your gut on this one.

Next: The Bear Argument