If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at American Eagle Outfitters (NYSE:AEO) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on American Eagle Outfitters is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = US$327m ÷ (US$3.4b - US$762m) (Based on the trailing twelve months to July 2023).
So, American Eagle Outfitters has an ROCE of 12%. By itself that's a normal return on capital and it's in line with the industry's average returns of 12%.
View our latest analysis for American Eagle Outfitters
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.
So How Is American Eagle Outfitters' ROCE Trending?
In terms of American Eagle Outfitters' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 27% over the last five years. However it looks like American Eagle Outfitters might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.
The Key Takeaway
To conclude, we've found that American Eagle Outfitters is reinvesting in the business, but returns have been falling. Unsurprisingly, the stock has only gained 10% over the last five years, which potentially indicates that investors are accounting for this going forward. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.
If you'd like to know about the risks facing American Eagle Outfitters, we've discovered 2 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.
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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.