To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So while American Eagle Outfitters (NYSE:AEO) has a high ROCE right now, lets see what we can decipher from how returns are changing.
Return On Capital Employed (ROCE): What is it?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for American Eagle Outfitters, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.22 = US$620m ÷ (US$3.8b - US$870m) (Based on the trailing twelve months to October 2021).
Therefore, American Eagle Outfitters has an ROCE of 22%. On its own, that's a very good return and it's on par with the returns earned by companies in a similar industry.
In the above chart we have measured American Eagle Outfitters' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for American Eagle Outfitters.
How Are Returns Trending?
In terms of American Eagle Outfitters' historical ROCE movements, the trend isn't fantastic. To be more specific, while the ROCE is still high, it's fallen from 29% where it was five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
Our Take On American Eagle Outfitters' ROCE
While returns have fallen for American Eagle Outfitters in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. Furthermore the stock has climbed 75% over the last five years, it would appear that investors are upbeat about the future. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.
On a final note, we found 3 warning signs for American Eagle Outfitters (1 is significant) you should be aware of.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
American Eagle Outfitters
American Eagle Outfitters, Inc. operates as a specialty retailer that provides clothing, accessories, and personal care products under the American Eagle and Aerie brands in the United States and internationally.
Excellent balance sheet with proven track record.