Today we'll evaluate American Eagle Outfitters, Inc. (NYSE:AEO) to determine whether it could have potential as an investment idea. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First, we'll go over how we calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Return On Capital Employed (ROCE): What is it?
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
So, How Do We Calculate ROCE?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for American Eagle Outfitters:
0.13 = US$341m ÷ (US$3.5b - US$810m) (Based on the trailing twelve months to November 2019.)
So, American Eagle Outfitters has an ROCE of 13%.
Does American Eagle Outfitters Have A Good ROCE?
ROCE can be useful when making comparisons, such as between similar companies. It appears that American Eagle Outfitters's ROCE is fairly close to the Specialty Retail industry average of 11%. Regardless of where American Eagle Outfitters sits next to its industry, its ROCE in absolute terms appears satisfactory, and this company could be worth a closer look.
We can see that, American Eagle Outfitters currently has an ROCE of 13%, less than the 29% it reported 3 years ago. This makes us wonder if the business is facing new challenges. The image below shows how American Eagle Outfitters's ROCE compares to its industry, and you can click it to see more detail on its past growth.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for American Eagle Outfitters.
What Are Current Liabilities, And How Do They Affect American Eagle Outfitters's ROCE?
Current liabilities include invoices, such as supplier payments, short-term debt, or a tax bill, that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
American Eagle Outfitters has total assets of US$3.5b and current liabilities of US$810m. As a result, its current liabilities are equal to approximately 23% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On American Eagle Outfitters's ROCE
This is good to see, and with a sound ROCE, American Eagle Outfitters could be worth a closer look. American Eagle Outfitters shapes up well under this analysis, but it is far from the only business delivering excellent numbers . You might also want to check this free collection of companies delivering excellent earnings growth.
If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned.
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