Here's What's Concerning About American Eagle Outfitters' (NYSE:AEO) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at American Eagle Outfitters (NYSE:AEO) and its ROCE trend, we weren't exactly thrilled.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for American Eagle Outfitters:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.10 = US$274m ÷ (US$3.4b - US$769m) (Based on the trailing twelve months to January 2023).

Therefore, American Eagle Outfitters has an ROCE of 10%. In isolation, that's a pretty standard return but against the Specialty Retail industry average of 13%, it's not as good.

Check out our latest analysis for American Eagle Outfitters

Above you can see how the current ROCE for American Eagle Outfitters compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

SWOT Analysis for American Eagle Outfitters

How Are Returns Trending?

In terms of American Eagle Outfitters' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 25%, but since then they've fallen to 10%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

Our Take On American Eagle Outfitters' ROCE

To conclude, we've found that American Eagle Outfitters is reinvesting in the business, but returns have been falling. And investors appear hesitant that the trends will pick up because the stock has fallen 26% in the last five years. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

One more thing to note, we've identified 3 warning signs with American Eagle Outfitters and understanding them should be part of your investment process.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and 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.