A popular maxim among technical traders states that “the trend is your friend.” The logic is pretty simple; when you’re trying to decide which way to work with a stock (bearish or bullish), you should use the stock’s trend as your guide. If you’re thinking about taking a position that could cover 3 month’s of time or more, the smart way to apply the rule is use the stock’s long-term trend for that reference.
This approach works against the mindset of value-oriented and contrarian investors, because it opens up your investment universe to stocks that are already trading at high multiples of the price ratios more conservative methods use. The advantage that it offers, however is pretty simple: just because a stock is already trading at a high level does not automatically mean it is due to reverse and move down. It is also true that in order for a stock to establish a new high, it has to break above its latest high. American Eagle Outfitters, Inc. (AEO) is a great example of a stock that is the midst of a strong, long-term upward trend, and that could be setting up for another strong push even higher.
The trend for AEO is following a very similar track to the Consumer Discretionary sector in general, which is where this Specialty Retail stock fits. The entire sector has pulled back just a bit from recent peaks over the last week or so, and it is true that it could drop a little further. The strength of that longer trend, however means that the entire sector, and AEO specifically, is more likely in the near future to turn back to the upside and offer investors an opportunity to ride the stock a little further.
Fundamental and Value Profile
American Eagle Outfitters, Inc. (AEO Inc.) is a multi-brand specialty retailer. The Company offers a range of apparel and accessories for men and women under the American Eagle Outfitters Brand (AEO Brand), and intimates, apparel and personal care products for women under the Aerie brand. AEO Inc. operates stores in the United States, Canada, Mexico, Hong Kong, China and the United Kingdom. As of January 28, 2017, the Company operated over 1,000 retail stores and online at ae.com and aerie.com in the United States and internationally. Its company-owned retail stores are located in shopping malls, lifestyle centers and street locations in the United States, Canada, Mexico, China, Hong Kong and the United Kingdom. Its other brands include Tailgate and Todd Snyder New York. Tailgate is an apparel brand with a college town store concept. Todd Snyder New York is a menswear brand. As of January 28, 2017, the AEO brand operated 943 stores and online at www.ae.com. AEO has a current market cap of $4.2 billion.
- Earnings and Sales Growth: Over the last twelve months, earnings and sales both increased, with earnings growing almost 44%, while sales increased about 8%. Growing earnings faster than sales is difficult to do, and generally isn’t sustainable in the long-term; however it is also a good indication of a management’s ability to maximize their business operations.
- Free Cash Flow: AEO’s Free Cash Flow is healthy, at a little over $235 million. That number has increased in each of the past three quarters.
- Debt to Equity: AEO has a debt/equity ratio of 0, which means they carry little to no debt. That fact translates to a much lower level of financial risk for the company than most of its competitors carry. The company has good liquidity, with a little over $309 million in total cash and liquid assets. This also represents a significant improvement over the last year, when cash was around just $190 million.
- Dividend: AEO pays an annual dividend of $.55 per share, which at its current price translates to a dividend yield of about 2.33%.
- Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for AEO is $6.84 per share. At the stock’s current price, that translates to a Price/Book Ratio of 3.44. The historical average for the stock is only 2.5, suggesting the stock is overvalued by almost 50%, but the average for the Specialty Retail industry is 6.8, which is a reflection of current market conditions, as investors have consistently shown a willingness to price stocks in this industry at high multiples when the opportunity seems right. A target price of $46 per share, which is where the stock would be at par with the industry average, is probably not realistic, considering that its price has never exceeded $32 per share; it does, however suggest that a target somewhere in the $30 to $31 range under current conditions is probably not unreasonable.
Here’s a look at the stock’s latest technical chart.
- Current Price Action/Trends and Pivots: The diagonal blue line traces the stock’s upward trend over the past year, while the dashed red and green lines highlight the narrow trading range the stock has held between $23 and $25 for the past month or so. Don’t be surprised if the stock pushes below its immediate support at $23 to test the long-term trend line’s support somewhere around $21.
- Near-term Keys: If the stock can find a new surge of bullish momentum, it could break above the stock’s current high, and resistance around $25. That could give way to another surge to the $28 to $30 range. If the stock retraces back to around $21 and then pivots back to the upside, an aggressive trader would be tempted to bet on a resumption of the upward trend, but the higher probability trade would be to wait for a solid break above $25. The stock could break that upward trend line support, and if it goes even further to drop below pivot low support around $19, its next low could be found in the $13 to $14 range.