Is Gap Still a Buy After a 129% Three-Year Rally?

The retail sector has long been a volatile arena for investors, but Gap Inc. (GAP) has defied the odds in recent years. After a 129% rally since 2022, the stock now trades at $27.53 per share, raising a critical question: Is this a fair valuation for a company that has navigated supply chain chaos, shifting consumer preferences, and a competitive retail landscape? To answer this, we must dissect Gap's financial performance, brand dynamics, and valuation metrics through the lens of discounted cash flow (DCF) analysis, price-to-earnings (PE) ratios, and long-term growth projections.

Valuation Realism: DCF and PE Ratios

According to financial data, Gap's current PE ratio of 11.5x is significantly below the Specialty Retail industry average of 20.3x, suggesting the stock is undervalued relative to peers. This discount is even more compelling when considering the company's recent financial performance. For the third quarter of fiscal 2025, Gap reported net sales of $3.9 billion, a 3% year-over-year increase, with operating income of $334 million and diluted earnings per share (EPS) of $0.62. Analysts project adjusted EBITDA margins to reach 17.2% in 2026, further underpinning its profitability.

A DCF analysis offers a more granular view. Using a weighted average cost of capital (WACC) of 10.6%-a midpoint between the 9.1% and 12.1% range cited in recent models-the intrinsic value of Gap's stock is estimated at $26.56 to $28.95 per share according to valuation models. This aligns closely with the current price of $27.53, suggesting the stock is trading near its fair value. However, discrepancies in WACC calculations-ranging from 7.03% to 12.76%-highlight the sensitivity of DCF models to discount rate assumptions. A lower WACC would elevate intrinsic value estimates, while a higher WACC would reduce them.

Brand Performance: Momentum and Reset Challenges

Gap's brand portfolio is a mixed bag. Old Navy and Gap, its core brands, are driving growth. Old Navy reported $2.3 billion in Q3 sales, a 5% increase year-over-year, with comparable sales up 6%. Its success in denim, active wear, and culturally relevant partnerships has revitalized the brand. Similarly, Gap's "reinvigoration playbook" has delivered eight consecutive quarters of comparable sales growth, with Q3 sales up 6% to $951 million.

Athleta, however, remains a drag. The activewear brand reported an 11% decline in sales to $257 million in Q3, a setback attributed to inventory challenges and shifting consumer trends. Management has acknowledged the need for a strategic reset, which could take time to bear fruit. This duality-strong core brands versus underperforming segments-adds complexity to long-term growth projections.

Future Growth: Digital Expansion and Margin Discipline

Gap's long-term growth hinges on its ability to balance digital expansion with margin discipline. The company's digital sales now account for over 20% of total revenue according to industry analysis, a figure expected to rise as it invests in e-commerce and omnichannel strategies. However, elevated tariffs and inflationary pressures remain headwinds, particularly for merchandise margins. Analysts project free cash flow to grow from $784 million in the last twelve months to $932 million by 2035, a trajectory that assumes stable 2% revenue growth post-FY2025.

Risks and Rewards

While Gap's valuation appears reasonable, investors must weigh several risks. The retail sector's cyclicality means consumer spending could contract during economic downturns. Additionally, the company's reliance on Old Navy and Gap exposes it to fashion trends and inventory missteps. Athleta's reset, though necessary, may further pressure short-term margins.

Conversely, the stock's current discount to intrinsic value-estimated at 9.0% to 20.0% depending on the model-offers a margin of safety. A return to pre-pandemic growth rates in core brands, coupled with successful digital scaling, could unlock significant upside.

Conclusion: A Buy with Caution

Gap's stock is neither a screaming bargain nor a speculative play. At $27.53, it trades near its DCF-derived fair value, with a PE ratio that reflects its disciplined cost structure and improving margins. The company's strong performance in Old Navy and Gap, combined with a strategic reset for Athleta, positions it for moderate growth. However, investors should remain cautious about macroeconomic risks and the company's ability to sustain its turnaround. For those with a medium-term horizon and a tolerance for retail sector volatility, Gap remains a compelling buy-but not without vigilance.