The Gap, Inc. (NYSE:GPS) shares are down more than -5.34% this year and recently decreased -2.51% or -$0.83 to settle at $32.24. Laredo Petroleum, Inc. (NYSE:LPI), on the other hand, is down -17.72% year to date as of 03/12/2018. It currently trades at $8.73 and has returned -1.47% during the past week.
The Gap, Inc. (NYSE:GPS) and Laredo Petroleum, Inc. (NYSE:LPI) are the two most active stocks in the market based on today’s trading volumes. We will compare the two companies based on the strength of various metrics, including growth, profitability, risk, return, and valuation to determine if one is a better investment than the other.
The ability to grow earnings at a compound rate over time is a crucial determinant of investment value. Analysts expect GPS to grow earnings at a 10.63% annual rate over the next 5 years. Comparatively, LPI is expected to grow at a 12.52% annual rate. All else equal, LPI’s higher growth rate would imply a greater potential for capital appreciation.
Profitability and Returns
A high growth rate isn’t necessarily valuable to investors. In fact, companies that overinvest in low return projects just to achieve a high growth rate can actually destroy shareholder value. Profitability and returns are a measure of the quality of a company’s business and its growth opportunities. We’ll use EBITDA margin and Return on Investment (ROI) to measure this., compared to an EBITDA margin of 97.53% for Laredo Petroleum, Inc. (LPI). GPS’s ROI is 17.60% while LPI has a ROI of 14.40%. The interpretation is that GPS’s business generates a higher return on investment than LPI’s.
The value of a stock is simply the present value of its future free cash flows. GPS’s free cash flow (“FCF”) per share for the trailing twelve months was -0.42. Comparatively, LPI’s free cash flow per share was -0.24. On a percent-of-sales basis, GPS’s free cash flow was -1.03% while LPI converted -0.01% of its revenues into cash flow. This means that, for a given level of sales, LPI is able to generate more free cash flow for investors.
Liquidity and Financial Risk
Analysts look at liquidity and leverage ratios to assess how easily a company can cover its liabilities. GPS has a current ratio of 1.70 compared to 0.80 for LPI. This means that GPS can more easily cover its most immediate liabilities over the next twelve months. GPS’s debt-to-equity ratio is 0.41 versus a D/E of 1.03 for LPI. LPI is therefore the more solvent of the two companies, and has lower financial risk.
GPS trades at a forward P/E of 11.63, a P/B of 4.17, and a P/S of 0.78, compared to a forward P/E of 7.31, a P/B of 2.73, and a P/S of 2.48 for LPI. GPS is the cheaper of the two stocks on sales basis but is expensive in terms of P/E and P/B ratio. Given that earnings are what matter most to investors, analysts tend to place a greater weight on the P/E.
Analyst Price Targets and Opinions
Just because a stock is cheaper doesn’t mean there’s more value to be had. In order to assess value we need to compare the current price to where it’s likely to trade in the future. GPS is currently priced at a -5.81% to its one-year price target of 34.23. Comparatively, LPI is -30.77% relative to its price target of 12.61. This suggests that LPI is the better investment over the next year.
The average investment recommendation on a scale of 1 to 5 (1 being a strong buy, 3 a hold, and 5 a sell) is 3.00 for GPS and 2.60 for LPI, which implies that analysts are more bullish on the outlook for GPS.
Risk and Volatility
Beta is an important measure that gives investors a sense of the market risk associated with a particular stock. A beta above 1 signals above average market risk, while a beta below 1 implies below average volatility. GPS has a beta of 0.85 and LPI’s beta is 1.29. GPS’s shares are therefore the less volatile of the two stocks.
Insider Activity and Investor Sentiment
The analysis of insider buying and selling trends can be extended to the aggregate level. Short interest, which represents the percentage of a stock’s tradable shares currently being shorted, captures what the market as a whole feels about a stock. GPS has a short ratio of 6.04 compared to a short interest of 4.98 for LPI. This implies that the market is currently less bearish on the outlook for LPI.
Laredo Petroleum, Inc. (NYSE:LPI) beats The Gap, Inc. (NYSE:GPS) on a total of 9 of the 14 factors compared between the two stocks. LPI generates a higher return on investment, is more profitable, has higher cash flow per share and has a higher cash conversion rate. In terms of valuation, LPI is the cheaper of the two stocks on an earnings and book value, LPI is more undervalued relative to its price target. Finally, LPI has better sentiment signals based on short interest.