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Gap (NYSE:GAP) has had a rough three months with its share price down 23%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Gap's ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Is ROE Calculated?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Gap is:
26% = US$844m ÷ US$3.3b (Based on the trailing twelve months to February 2025).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.26.
See our latest analysis for Gap
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
A Side By Side comparison of Gap's Earnings Growth And 26% ROE
First thing first, we like that Gap has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 18% also doesn't go unnoticed by us. Under the circumstances, Gap's considerable five year net income growth of 49% was to be expected.
Next, on comparing with the industry net income growth, we found that Gap's growth is quite high when compared to the industry average growth of 14% in the same period, which is great to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Gap's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.