There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. However, after briefly looking over the numbers, we don't think American Eagle Outfitters (NYSE:AEO) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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)
0.0041 = US$11m ÷ (US$3.4b - US$858m) (Based on the trailing twelve months to January 2021).
Thus, American Eagle Outfitters has an ROCE of 0.4%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 13%.
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'd like, you can check out the forecasts from the analysts covering American Eagle Outfitters here for free.
So How Is American Eagle Outfitters' ROCE Trending?
When we looked at the ROCE trend at American Eagle Outfitters, we didn't gain much confidence. To be more specific, ROCE has fallen from 28% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
The Bottom Line
In summary, we're somewhat concerned by American Eagle Outfitters' diminishing returns on increasing amounts of capital. Yet despite these poor fundamentals, the stock has gained a huge 170% over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
Like most companies, American Eagle Outfitters does come with some risks, and we've found 3 warning signs that you should be aware of.
While American Eagle Outfitters isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
This article by Simply Wall St is general in nature. 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.