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Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at American Eagle Outfitters (NYSE:AEO), it didn't seem to tick all of these boxes.
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. 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$335m ÷ (US$3.5b - US$831m) (Based on the trailing twelve months to October 2023).
Therefore, American Eagle Outfitters has an ROCE of 12%. That's a pretty standard return and it's in line with the industry average of 12%.
See 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'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?
In terms of American Eagle Outfitters' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 26%, but since then they've fallen to 12%. 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.
In Conclusion...
Bringing it all together, while we're somewhat encouraged by American Eagle Outfitters' reinvestment in its own business, we're aware that returns are shrinking. Additionally, the stock's total return to shareholders over the last five years has been flat, which isn't too surprising. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.