While ModernGraham supports the bottom-up approach to investing, many investors do utilize the top-down method, whereby an industry is selected before the company itself. With that in mind, this article will take a brief look at the best companies of the apparel industry, selecting the most promising investment opportunities within the industry, and giving a broad look into the industry as a whole.
Out of the more than 540 companies reviewed by ModernGraham, 10 were identified as being closely related to the apparel industry. Of those, only one is suitable for the Defensive Investor, eight are suitable for the Enterprising Investor, and the remaining one is considered speculative at this time. Excluding any extreme outliers, the average company was rated as being priced at 107.89% to its MG Value (estimated intrinsic value), with an average PEmg ratio of 23.85. The industry as a whole, therefore would appear to be fairly valued, particularly in comparison to the market (see Mr. Market's Mental State).
The Elite
The following companies have been rated as undervalued and suitable for either the Defensive Investor or the Enterprising Investor:
Gap Inc. (GPS)
Gap Inc. is suitable for the Enterprising Investor but not the more conservative Defensive Investor. The Defensive Investor is concerned by the low current ratio and the high PB ratio, while the Enterprising Investor has no initial concerns. Therefore, all Enterprising Investors should feel very comfortable proceeding with the next stage of the analysis, which is a determination of an estimate of intrinsic value.
From a valuation side of things, the company has grown its EPSmg (normalized earnings) from $1.59 in 2012 to an estimated $2.63 for 2016. This level of demonstrated growth outpaces the market's implied estimate for earnings growth of 2.94% over the next 7-10 years.
The company's recent earnings history shows an average annual growth in EPSmg of around 13%. The ModernGraham valuation model reduces such a rate to a more conservative figure, assuming some slowdown will occur, but still returns an estimate of intrinsic value well above the current price, indicating Gap Inc. is significantly undervalued at the present time. (See the full valuation)
