Will Gap Help You Retire Rich?

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Now more than ever, a comfortable retirement depends on secure, stable investments. Unfortunately, the right stocks for retirement won't just fall into your lap. In this series, I look at 10 measures to show what makes a great retirement-oriented stock.

In an industry where fashion turns on a dime, Gap (NYS: GPS) has been around for a very, very long time. But even though the retailer's stores have been around for decades, the company has struggled for years to return to its former glory. With so many competitors, though, Gap has a tough task trying to regain a leadership role in the industry. Can the retailer get the job done? Below, we'll revisit how Gap does on our 10-point scale.

The right stocks for retirees
With decades to go before you need to tap your investments, you can take greater risks, weighing the chance of big losses against the potential for mind-blowing returns. But as retirement approaches, you no longer have the luxury of waiting out a downturn.


Sure, you still want good returns, but you also need to manage your risk and protect yourself against bear markets, which can maul your finances at the worst possible time. The right stocks combine both of these elements in a single investment.

When scrutinizing a stock, retirees should look for:

  • Size. Most retirees would rather not take a flyer on unproven businesses. Bigger companies may lack their smaller counterparts' growth potential, but they do offer greater security.
  • Consistency. While many investors look for fast-growing companies, conservative investors want to see steady, consistent gains in revenue, free cash flow, and other key metrics. Slow growth won't make headlines, but it will help prevent the kind of ugly surprises that suddenly torpedo a stock's share price.
  • Stock stability. Conservative retirement investors prefer investments that move less dramatically than typical stocks, and they particularly want to avoid big losses. These investments will give up some gains during bull markets, but they won't fall as far or as fast during bear markets. Beta measures volatility, but we also want a track record of solid performance as well.
  • Valuation. No one can afford to pay too much for a stock, even if its prospects are good. Using normalized earnings multiples helps smooth out one-time effects, giving you a longer-term context.
  • Dividends. Most of all, retirees look for stocks that can provide income through dividends. Retirees want healthy payouts now and consistent dividend growth over time -- as long as it doesn't jeopardize the company's financial health.

With those factors in mind, let's take a closer look at Gap.

Factor

What We Want to See

Actual

Pass or Fail?

SizeMarket cap > $10 billion$14.4 billionPass
ConsistencyRevenue growth > 0% in at least four of five past years3 yearsFail
 Free cash flow growth > 0% in at least four of past five years2 yearsFail
Stock stabilityBeta < 0.91.25Fail
 Worst loss in past five years no greater than 20%(35.9%)Fail
ValuationNormalized P/E < 1817.45Pass
DividendsCurrent yield > 2%1.7%Fail
 5-year dividend growth > 10%7.6%Fail
 Streak of dividend increases >= 10 years5 yearsFail
 Payout ratio < 75%27.7%Pass
    
 Total score 3 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Gap last year, the company has dropped two points. With shares up 50% in the past year, though, most investors aren't complaining that the stock's dividend yield has fallen, although slower dividend growth isn't good news.

Gap's recent success stems from it taking advantage of a gift from nature in the form of an unseasonably warm winter. Moreover, it finally had success with its spring line of clothes, even as Chico's FAS (NYS: CHS) , ANN (NYS: ANN) , and American Eagle (NYS: AEO) have seen their inventory figures move higher, reflecting a less eager reception from shoppers for their new lineups.

But Gap still has investors skeptical about its future prospects. Although macroeconomic conditions have improved somewhat, the danger of a continuing slow economy or even another recession looms large over the retail sector. As Gap reaches a pretty healthy valuation, it's more vulnerable to a reversal in the economy or in its own turnaround.

One area that hasn't drawn much attention from investors is its Piperlime boutique apparel website. But with the company planning to open a physical store in Manhattan later this year, the resulting attention could invigorate the concept. That probably won't be enough to give the company comparable figures to lululemon athletica (NAS: LULU) or other high-margin niche retailers, but it could still be a step in the right direction.

For retirees and other conservative investors, though, the stock already reflects a lot of enthusiasm over the company. With a yield below 2% and a rising valuation, investors would be better off waiting until things look a bit less frothy before considering Gap in their retirement portfolios.

Keep searching
Finding exactly the right stock to retire with is a tough task, but it's not impossible. Searching for the best candidates will help improve your investing skills, and teach you how to separate the right stocks from the risky ones.

If you really want to retire rich, no one stock will get the job done. Instead, you need to know how to prepare for your golden years. The Motley Fool's latest special report will give you all the details you need to get a smart investing plan going, plus it reveals three smart stocks for a rich retirement. But don't waste another minute -- click here and read it today.

Add Gap to My Watchlist, which will aggregate our Foolish analysis on it and all your other stocks.

At the time this article was published Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. The Motley Fool owns shares of lululemon athletica. Motley Fool newsletter services have recommended buying shares of lululemon athletica. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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