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The Gap vs J. Crew: Analyst's Toolkit

BOSTON (TheStreet) -- Conventional wisdom suggests that, during a recession, cash-strapped shoppers trade down from pricier shops such as J. Crew (JCG) and The Gap (GPS) to discount retailers like Wal-Mart (WMT) and Target (TGT).

Those companies' share prices haven't borne that out. Over the past year, J. Crew and The Gap have jumped 19% and 18%, respectively, beating the S&P 500 Index's decline of 12% and surpassing Wal-Mart and Target, which have fallen by 14% and 1.9%, respectively.

Investors may have avoided J. Crew and The Gap based on sound reasoning: Counter-cyclical stocks are the best bet in a downturn. Recent performance, however, makes J. Crew and The Gap worthy of a second look.

Drilling down into key metrics will provide a stable foundation for an investment decision.

P/E Ratio

J. Crew: 51.7; The Gap: 16.7.

By looking at the price-to-earnings ratio, it's clear J. Crew is overvalued. At 51.7, J. Crew's P/E ratio is three times that of The Gap. Much of the disconnect may have arisen during the stock's steep run-up starting in March, fueled by a big earnings surprise for the quarter ending in April. The Gap, on the other hand, has been steadily beating analysts' expectations throughout the recession but has lacked a quarter with the same surprise shock. By this measure, The Gap looks far more reasonably priced, making it the better investment.

Beta

J. Crew: 1.58; The Gap: 1.27.

The Gap is also much less volatile than J. Crew. With a beta of 1.27, The Gap will move far less dramatically than J. Crew, which has a beta of nearly 1.6. (A perfect correlation with the overall market is 1.) Investors looking for a stable investment should give the edge to The Gap, since the lower volatility will be more in line with conservative investors' comfort levels. J. Crew, however, has shown more possibility to pop on strong economic news, making it a more attractive investment for those looking for the higher returns that sometimes come with higher risk.

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