Don't Forget to Mind the Gap

Don't get me wrong -- I'm not all that sanguine about the near-term prospects for Gap(GPS Quote). After all, the company has reported absolutely horrific same-store-sales numbers for the past several months. Plus, it's been forced to mark down prices pretty aggressively just to get people to go into its stores. Still, I can't help but think that the stock is probably oversold at this point.

Why?

Keep in mind that management has actively sought to trim expenses during these trying times. By discounting slower-moving merchandise, the company has reduced the possibility of any major write-offs heading into the new year. In addition, it has also scaled back future growth plans, reduced its headcount and closed several distribution facilities. My point is that most of the bad news has already been factored into the share price. And management's efforts to stop the bleeding will have a positive impact on results going forward.

Also, take a gander at Gap's financials. Believe it or not, the company is still kicking off some decent cash flow from operations. And it has more than $722 million in cash -- more than enough to bide the company some time if it needs it. My point here is that the company isn't in dire straits, as most retail and institutional investors seem to assume.

Potential investors should also consider that based upon historical valuations, the company is cheap. In fact, over the past five years Gap has traded anywhere between 2.7 and 22.3 times book value. But currently it trades at just 3.6 times book. During that same time frame the company has also traded anywhere between 0.6 and 3.9 times sales, but they now trade at just 0.86 times sales. So if history is any indicator, there is a lot of room for multiple expansion, particularly since most sell-side analysts think the company can still generate double-digit earnings growth over the next three to five years.

In short, it appears as though investors have placed little value on the company's name, store footprint, proven ability to keep up with the latest fashions, or its future earnings potential. So could the stock get hit a bit more, particularly during tax-loss selling season? Sure. But over the long haul, once the cloud over the retail sector begins to lift, I suspect that the shares will rebound in short order. Just be patient. Who won today's Face Off? Glenn Curtis Tim Arango