It is hard to get excited after looking at American Eagle Outfitters' (NYSE:AEO) recent performance, when its stock has declined 18% over the past three months. However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to American Eagle Outfitters' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How Is ROE Calculated?

ROE can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for American Eagle Outfitters is:

15% = US$248m ÷ US$1.7b (Based on the trailing twelve months to August 2024).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.15 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

American Eagle Outfitters' Earnings Growth And 15% ROE

At first glance, American Eagle Outfitters seems to have a decent ROE. Even so, when compared with the average industry ROE of 19%, we aren't very excited. American Eagle Outfitters was still able to see a decent net income growth of 15% over the past five years. So, there might be other aspects that are positively influencing earnings growth. For instance, the company has a low payout ratio or is being managed efficiently. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this also provides some context to the earnings growth seen by the company.

As a next step, we compared American Eagle Outfitters' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 17% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is American Eagle Outfitters fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is American Eagle Outfitters Using Its Retained Earnings Effectively?

American Eagle Outfitters has a healthy combination of a moderate three-year median payout ratio of 39% (or a retention ratio of 61%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Moreover, American Eagle Outfitters is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 24% over the next three years. As a result, the expected drop in American Eagle Outfitters' payout ratio explains the anticipated rise in the company's future ROE to 19%, over the same period.

Conclusion

Overall, we are quite pleased with American Eagle Outfitters' performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.