Benjamin Graham taught that Intelligent Investors must do a thorough fundamental analysis of investment opportunities to determine their intrinsic value and inherent risk. Â This isÂ best done by utilizing a systematic approach to analysis that will provide investors with a sense of how a specific company compares to another companyÂ or by reviewing theÂ 5 Most Undervalued Companies for the Defensive Investor – July 2015.Â By using theÂ ModernGraham methodÂ one can review a company’s historical accomplishments and determine an intrinsic value that can be compared across industries. Â What follows is a stock analysis showing a specific look at how American Eagle Outfitters (AEO)Â fares in theÂ ModernGraham valuation model.
Company ProfileÂ (obtained fromÂ Google Finance): American Eagle Outfitters, Inc. is an apparel and accessories retailer. The Company offers clothing, accessories and personal care products. The Company operates under the American Eagle Outfitters and aerie by American Eagle Outfitters brands. The American Eagle Outfitters brand offers denims, pants, shorts, sweaters, fleece, outerwear, graphic t-shirts, footwear and accessories. The aerie brand is a collection of intimates and personal care products for women, such as bras and undies at the core, and offerings in sleep, swim and apparel. The Company offers its products online at ae.com and aerie.com and at various international store locations managed by third-party operators. The Company operates around 1,000 retail stores in the United States and internationally, 955 American Eagle Outfitters stores, 101 aerie stand-alone stores and 99 third-party operated stores. The Company has stores in the United States, Canada, Mexico, Hong Kong, China and the United Kingdom.
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Defensive Investor – must pass at least 6 of the following 7 tests: Score = 4/7
- Adequate Size of Enterprise – market capitalization of at least $2 billion -Â PASS
- Sufficiently Strong Financial Condition – current ratio greater than 2 -Â PASS
- Earnings Stability – positive earnings per share for at least 10 straight years -PASS
- Dividend Record – has paid a dividend for at least 10 straight years -Â PASS
- Earnings Growth – earnings per share has increased by at least 1/3 over the last 10 years using 3 year averages at beginning and end of period -Â FAIL
- Moderate PEmg ratio – PEmg is less than 20 -Â FAIL
- Moderate Price to Assets – PB ratio is less than 2.5 or PB x PEmg is less than 50 -Â FAIL
Enterprising Investor – must pass at least 4Â of the following 5 tests or be suitable for a defensive investor: Score = 4/5
- Sufficiently Strong Financial Condition, Part 1 – current ratio greater than 1.5 -Â PASS
- Sufficiently Strong Financial Condition, Part 2 – Debt to Net Current Assets ratio less than 1.1 -Â PASS
- Earnings Stability – positive earnings per share for at least 5 years -Â PASS
- Dividend Record – currently pays a dividend -Â PASS
- Earnings growth – EPSmg greater than 5 years ago -Â FAIL
|Value Based on 3% Growth||$10.16|
|Value Based on 0% Growth||$5.96|
|Market Implied Growth Rate||8.13%|
|Net Current Asset Value (NCAV)||$1.70|
Balance Sheet – AprilÂ 2015
Earnings Per Share
Earnings Per ShareÂ – ModernGraham
American Eagle OutfittersÂ qualifies for the Enterprising Investor but not the more conservative Defensive Investor. Â The Defensive Investor is concerned with the insufficient earnings growthÂ over the last ten years as well as the high PEmg and PB ratios. Â The Enterprising InvestorÂ is only initially concerned with the lack of earnings growth over the last five years. Â As a result, all Enterprising InvestorsÂ following the ModernGraham approach based on Benjamin Graham’s methods should feel comfortable proceeding with the evaluation. Â As for a valuation,Â the company appears to be overvalued after seeingÂ itsÂ EPSmg (normalized earnings) decline from $0.84Â in 2012 to an estimatedÂ $0.70Â for 2016. Â This level of demonstrated earnings growthÂ does not supportÂ the market’s implied estimate of 8.13% annual earnings growth over the next 7-10 years.Â As a result, the ModernGrahamÂ valuation model, based on Benjamin Graham’s formula, returns an estimate of intrinsic value belowÂ the price.
The next part of the analysis is up to individual investors, and requires discussion of the company’s prospects. Â What do you think? Â What value would you put on American Eagle Outfitters (AEO)? Â Where do you see the company going in the future? Â Is there a company you like better? Â Leave aÂ comment on ourÂ Facebook pageÂ or mentionÂ @ModernGrahamÂ on Twitter to discuss.
Disclaimer: Â The author did not hold aÂ position in any company mentioned in this articleÂ at the time of publication and had no intention of changing that position within the next 72 hours. Â Logo taken from Wikipedia for the sole purpose of identifying the company; this article is not affiliated with the company in any manner.