The Gap, Inc. (NYSE:GAP) Surges 30% Yet Its Low P/E Is No Reason For Excitement

The Gap, Inc. (NYSE:GAP) shareholders would be excited to see that the share price has had a great month, posting a 30% gain and recovering from prior weakness. While recent buyers may be laughing, long-term holders might not be as pleased since the recent gain only brings the stock back to where it started a year ago.

Even after such a large jump in price, Gap may still be sending bullish signals at the moment with its price-to-earnings (or "P/E") ratio of 10.2x, since almost half of all companies in the United States have P/E ratios greater than 18x and even P/E's higher than 32x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

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Recent times have been advantageous for Gap as its earnings have been rising faster than most other companies. One possibility is that the P/E is low because investors think this strong earnings performance might be less impressive moving forward. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favour.

See our latest analysis for Gap

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Gap.

Is There Any Growth For Gap?

There's an inherent assumption that a company should underperform the market for P/E ratios like Gap's to be considered reasonable.

Retrospectively, the last year delivered an exceptional 69% gain to the company's bottom line. Pleasingly, EPS has also lifted 231% in aggregate from three years ago, thanks to the last 12 months of growth. So we can start by confirming that the company has done a great job of growing earnings over that time.

Looking ahead now, EPS is anticipated to climb by 3.2% per year during the coming three years according to the analysts following the company. Meanwhile, the rest of the market is forecast to expand by 10% each year, which is noticeably more attractive.

In light of this, it's understandable that Gap's P/E sits below the majority of other companies. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.

The Bottom Line On Gap's P/E

The latest share price surge wasn't enough to lift Gap's P/E close to the market median. While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Gap maintains its low P/E on the weakness of its forecast growth being lower than the wider market, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. It's hard to see the share price rising strongly in the near future under these circumstances.

We don't want to rain on the parade too much, but we did also find 1 warning sign for Gap that you need to be mindful of.

If these risks are making you reconsider your opinion on Gap, explore our interactive list of high quality stocks to get an idea of what else is out there.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.