A Lesson From Gap's Stumble

 | Oct 11, 2013 | 12:00 PM EDT  | Comments
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The poor results at Gap Stores (GPS) offer a portfolio management lesson that I experienced personally and want to offer as part of a "teachable moment."

My growth-at-a-reasonable-price -- or "GARP" -- portfolio bought Gap on Dec. 10, 2012, at $31.52, under a thesis that earnings momentum would be solid in 2013 as the company executes better on managing its assortment and moves toward more "basics" as the economy falters. In fact, the stock performed well through the summer, as EPS estimates were steadily ratcheted upward and the company put up good comps and accelerating sales and margins.

GPS Estimate Trends

However, the trend turned late in the summer, as sundry forces caused sales at retailers, especially soft goods, to slow substantially. Gap was still performing well, but the upward revisions in earnings estimates started to weaken, when ranked against other names in the stock market. In fact, estimates were never really cut until very recently, but they stopped going up at a time when other names were still exhibiting earnings momentum. Conditions did not look bad at Gap, but they were starting to look average.

GPS Revision Trends

The cardinal rule in my GARP strategy is to own only the most attractive names available. If I would not be a buyer of a stock at that moment, I should be a seller to replace it. The combination of average earnings performance and suspicion of continued slowing in retail, and better alternatives within the group, led me to sell Gap on Oct. 7 at $40.14, booking an 18% gain in the process. (The better alternative was Best Buy (BBY). I swapped completely out of Gap and into Best Buy, but we'll save that detail for another post.)

As we saw last night, Gap posted very poor comps, and while management tried to be cheery about full-year goals, it had to concede a soft retail environment. The comp was -3% against a consensus expectation of +1.8%. I am very happy to be gone in this name.

The lesson for your portfolio management effort is simple: Don't wait for fundamentals to be bad before you sell. You should be a seller when fundamentals simply are not great. A stock that goes from great to bad will pass through average. When your names are no longer great, no longer cause you to bubble with enthusiasm, then say goodbye and look for the names that do.

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