Fill In Your Portfolio Gaps With This Apparel Giant

| About: The Gap, (GPS)

Finding stocks that have experienced tremendous growth in the past is not too challenging but as the old mantra goes: past performance does not guarantee future results. That being said, many of these stocks may deserve a second look. After all if the fundamentals are sound and future growth opportunities still exist, investors may be able to still cash in on continued growth. Of course if these conditions are not met it may be a good idea for investors to take a pass and keep searching.

One company that has experienced phenomenal recent growth is The Gap Inc. (NYSE:GPS). As of July 26, 2013 the company's share price has risen 49.52% year-to-date vs. only 18.60% for the S&P 500, and 55.75% over the past year vs. only 24.14% for the S&P 500. Over the long-term the company's share price has risen 179.18% over the past five years vs. only 34.50% for the S&P 500, and 137.25% over the past ten years vs. only 69.39% for the S&P 500. Over the even longer-term the stock has gained 2,286.65% since January 5, 1990 vs. 378.68% for the S&P500, and 89,076.47% since January 4, 1980 vs. 1,468.67% for the S&P 500. Going all the way back to the company's IPO The Gap Inc. has returned 65,244.83% to lucky enough investors compared to only a gain of 1,746.38% for the S&P 500. On top of all this The Gap Inc. plans to pay a dividend of $0.60 per share for 2013.

The Gap Inc. is a global apparel retail company offering apparel, accessories, and personal care products, for men, women, children, and babies. The company operates stores in the United States, Canada, the United Kingdom, France, Ireland, Japan, China, and Italy. The company has franchise agreements for its Gap and Banana Republic brands throughout Asia, Australia, Eastern Europe, Latin America, the Middle East, and Africa. The company also sells products online in over 80 countries. The Gap Inc. operates six brands: Gap (the company's flagship brand and the sub-brands: GapKids, babyGap, and GapBody), Banana Republic (acquired in 1983), Old Navy (launched in 1994), Piperlime (launched in 2006 offering private label items at various price points), Athleta (acquired in 2008 offering various women's active wear), and Intermix (acquired in 2012 offering luxury designs by up-and-coming designers and exclusive content).

What sets The Gap Inc. apart from its competitors is its diverse brand offerings. By taking advantage of a variety of product types, demographics, and price points The Gap Inc. is able to position itself to take advantage of opportunities across a variety of segments while minimizing overexposure to any one segment in particular.

Despite bumpy income statements between 2010 and 2012 the company has continually been able to increase its earnings per share. From 2010 to 2012 net sales increased 6.7% from about $14.7 billion in 2010, to about $14.5 billion in 2011, to about $15.7 billion in 2012. Over the same time period the costs of goods sold and occupancy expenses increased 12% (largely attributed to higher cotton prices) from about $8.8 billion, to about $9.3 billion, to about $9.5 billion. Gross profits managed to increase 4.8% from about $5.9 billion, to $5.3 billion, to $6.2 billion. Operating expenses also increased 7.9% (largely attributed to increased marketing and store-related expenses) from about $3.9 billion, to about $3.8 billion, to about $4.2 billion. This resulted in a slight 1.3% fall in operating income from $1.968 billion, to $1.438 billion, to $1.942 billion. It also resulted in a 6.1% fall in net income from $1.204 billion, to $833 million, to $1.135 billion. The weighted-average number of diluted shares decreased 31.4% from 641 million to 488 million. Earnings per diluted share increased 25% from $1.88 per diluted share to $2.35 per diluted share. Cash dividends declared and paid per share increased 25% from $0.40 per share to $0.50 per share.

The Gap Inc. has a healthy balance sheet that has been steadily improving since taking a hit during fiscal 2011. Before 2011 the company was free of long-term debt but throughout 2011 The Gap Inc. took on about $1.6 billion dollars' worth with a five-year term. The company did this to establish a more optimal capital system, fund stock repurchases, and take advantage of what they believe to be favorable market conditions. This resulted in total long-term liabilities rising a worrisome 185.3% from $890 million at the end of 2010 to a little over $2.5 billion at the end of 2011. Fortunately for the company and its shareholders the situation has since been improving. As of the end of the first quarter of 2013 long-term debt has decreased 22.4% to about $1.25 billion and total long-term liabilities have decreased 14.3% to about $2.2 billion. This has improved the company's debt-equity ratio from 1.69 to 1.35. The company currently maintains an acceptable quick ratio of 1.15.

Looking for continued success I see two main areas for the company, including: improving the fundamentals and expansion in emerging markets.

While improving its fundamentals is heavily dependent upon other growth areas it is critical for continued positive performance. The two specific areas the company needs to focus on are controlling costs and reducing debt. Despite increasing net sales over the past couple of years net income has actually fallen slightly. It's never a good sign when a company makes less money with more revenue. It is not enough for the company to focus on increasing sales while its margin drop, the company must figure out how to control its rising costs in order to best reap the benefits of increasing sales. While the company's current level of long-term debt seems manageable and debt is not inherently bad if used effectively by taking on so much in just one year, the company has demonstrated how large amounts of debt may be required at one time. By reducing its debt load The Gap Inc. frees up more credit for future use as well as reduces interest payments. Of course paying off too much too fast can result in missed opportunities from not investing in the company and can deplete cash reserves, leaving an inadequate cushion. By improving the underlying fundamentals The Gap Inc. will place itself in a much better position to focus on growth and capture the associated rewards.

While developed markets do have the most prosperous consumers and likely will for the foreseeable future, emerging markets represent about 80% of the world's population and consists of a rising middle class wanting the Western lifestyle. Expanding into the new markets is key to continued growth at a time when developed markets are becoming saturated. The company has already expanded company-operated stores into China and has franchises in many other developing markets. However in order to do so The Gap Inc. will not only have to compete with other multinationals wanting a piece of the pie but also already established local brands.

As with any business and especially because of the nature of the company's industry, The Gap Inc. has some associated general risks. The company is heavily dependent upon the global economy and consumer levels. Changes for the worst in these areas would negatively affect the company's performance. The apparel retail industry is a highly competitive one and The Gap Inc. would suffer if it were unable to keep up with its competitors, accurately predict apparel trends and consumer preferences, and obtain prime real estate. Much of the company's success is dependent upon maintaining positive images for its brands and the company as a whole and any deterioration of these brands will also result in deterioration of performance. The Gap Inc utilized third-party suppliers so risks such as supplier disruptions, changes in regulations, failure of suppliers to adhere to the company's code of vendor conduct, and various other factors outside of the company's control could negatively affect the company.

All things considered I would definitely rate The Gap Inc. as a buy. The company has experienced rough patches throughout its years but always seems to manage to come up ahead. While I am weary of the company's rising costs in comparison to revenue I do not see it as cause for alarm at this point as I am confident in the progress the company is making and instead see it as an opportunity to invest while conditions improve. The company has seen its share price rise tremendously in recent years but the company has a diverse variety of brands, steadily improving fundamentals, and plenty of opportunities for continued growth, and for these reasons I believe the Gap Inc. still has plenty of further growth in its future.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.