Hidden Gem – GPS: economic earnings are rising faster than reported accounting earnings b/c the company lowered the capital employed to run the business. GAAP earnings do not capture increases in the capital efficiency of businesses.

Like all of our Most Attractive Stocks for June, GAP offers compelling Risk/Reward because:

1. Cheap valuation: the current stock price ($21.80) implies the company’s profits will never grow from current levels – with such low expectations – downside is low and upside potential for the stock is higher
2. Rising and high level of cash flow: with a top-quintile ROIC, GPS is one of the most profitable companies in the U.S. Our models shows cash flows are rising significantly and more than reported EPS suggest. So, downside risk in the stock is low as the market is underestimating the cash flows of the business and upside is higher b/c once the market recognizes the true cash flows, the valuation of the company will rectify.

Full details are in our Free Report on GPS. See Appendix 4 to learn how GPS increased NOPAT by cutting costs and increasing its NOPAT Margin. See Appendix 5 for details on how GPS cut its Invested Capital and increased its Invested Capital Turnover. Appendix 7 (in the Return on Invested Capital section) shows how the improved NOPAT Margin and Invested Capital Turns result in a large increase in ROIC (to 15.3% from 12.0%) and Economic Profit, which rose by $164mm while Net Income rose by only $135mm.

Note: Stock pick of the week is updated every Tuesday.