Gap (GPS) is done growing, but its shareholders needn t continue to amass losses. New management has rightly begun pruning the overstretched clothier. Sales are sliding, but profits are plump and cash flow, plentiful. Now what is needed to turn a lousy stock into a lucrative one is a radical change to the dividend policy.

America has roughly one Gap, Old Navy or Banana Republic clothing store for every five McDonald s. Consider how often you stepped out for a hamburger in the past year vs. how often you shopped for jeans, and you ll surely conclude the nation is over-Gapped. Harder evidence: Companywide sales at longstanding stores, a key gauge of whether a chain ought to expand, have fallen for 17 straight quarters. Forget about the stock price s 45% tumble over the past year. That is merely on par with other clothing sellers amid the sharpest decline in consumer spending in decades. Gap s woes started well earlier. Since the beginning of 2000 the stock price has shrunk by three-quarters.

See for yourself: Have a look at some of my recent video rants on dividends here and here For a critique of what s on offer at Gap, I ll defer to Randal Konik, who follows clothing chains for Jefferies & Co., a New York investment bank, and who started coverage of Gap shares in late October with a Hold rating. Konik calls Gap past its prime and its brands aged. Gap s fashion basics saw fierce demand during the casualization of the workplace in the early 1990s. But the brands have devolved from cool to commodity, according to Konik, and smaller, bolder chains like Aeropostale (ARO) and Abercrombie (ANF) are siphoning share from Gap, just as it once stole sales from mall anchors like JC Penney (JCP) .

Perhaps most disappointing of late has been Old Navy, Gap s cheapest brand. In a year when customers are trading down and top performers include Wal-Mart (WMT) and BJ s Wholesale Club (BJ), Old Navy has underperformed Gap, Banana Republic and just about everyone else, with sales at longstanding stores plunging 18% last quarter.

Third-quarter results for Gap are expected Thursday. Sales numbers have already been reported; they re ugly. Earnings per share, remarkably, are expected to increase 13%. I can t vouch for the reliability of Wall Street s forecast, but for Gap, there s a glint of hope buried in the rubble. A year and a half ago I called readers attention to the company s web site as an example of how some retailers train customers to wait for sales. Looking at men s jeans, Gap listed nearly 60 pairs with 29% of them on sale. Today the site shows a quarter fewer jeans with only a couple on sale. That s anecdotal, but a trimming of inventory and more judicious discounting helped Gap grow profits by 51% in its second quarter, even as sales slipped. Also promising: Management says it will reduce square footage by 15% over the next three years by closing underperforming stores and using smaller formats. That will save on rent.

The real opportunity for shareholders lies in Gap s dividend. It is 34 cents a year now, paid quarterly. The stock s crumble to $10 and change has put its yield at just over 3%. But that s not enough. I want Gap to increase its yearly payments to $1, for a yield of close to 10%, and to commit to making payments indefinitely.

Three reasons. First, Gap can afford it. Its balance sheet is pristine, with net cash of more than $2 a share. The company clears massive amounts of free cash more than $1 a share each year, even after dividends are paid. Second, other alternatives for the cash are worse. This includes capital investments; thankfully, those ought to shrink, with little need to expand. It also includes share repurchases. Gap will have spent nearly $6 billion on stock in five years by the close of this year, all at prices well higher than today s. It s time to unleash that cash in the form of a fat dividend, which will do more to lure buyers.

as illustrated in the second of the aforementioned videos and substantiated here. Gap pays about a third of its profits as dividends. It s tempting for accomplished executives to believe that they re better stewards for the bulk of profit than shareholders. Evidence says just the opposite. Companies that pay out the bulk of profits as dividends actually grow earnings faster than companies that skimp.

I ve no doubt that Gap will find fashion geniuses to freshen its brands, and the bosses have taken baby steps toward restructuring the business. A turnaround will take years, but while Gap must get smaller during that time, its stock price needn t. Clothing shoppers can be difficult to figure out, but stock investors are easy. Giant, reliable dividends never go out of fashion. Gap s low stock price, accessorized with a yearly dividend increase to $1 a share, would surely prove a hit in 2009.

Gap turned up recently on a search for companies with considerable financial capacity modest debt and ample free cash flow along with decent dividends. Have a look at all six screen survivors if you like.