Let American Eagle Soar

American Eagle Outfitters is surviving and prospering, despite a tough industry. Its Aerie brand of lingerie has garnered wide acceptance. Earnings per share for this fiscal year -- which ends Feb. 1, 2020 -- are expected to rise to $1.60, the firm's best showing since 2007, before The Great Recession. Analysts see fiscal 2020 profits as even better, at about $1.74. AEO is debt-free, has no defined benefit plan and held over $425 million in cash as of Feb. 2. Clearly American Eagle has mastered the art of catering to their target market, mall shoppers who are 15 to 25 years old. Momentum traders pushed AEO to almost $30, and 20.2-times earnings last October. As of this mid-year, those same shares were quoted at just $16.90, at only 10.9-times this year's estimate. At that price shareholders receive 3.26% in current yield. The data below show that AEO's average price-to-earnings runs about 16-times, while its typical yield has been 3.05%. Four of AEO's five previous best buying opportunities (green-starred below) started their rallies from below-average multiples. All five offered better-than-typical dividends. American Eagle's end of June valuation looks remarkably similar to those excellent entry points. Conversely, three of four of AEO's should have sold moments (red-starred) reflected higher-than-normal price-to-earnings. All four showed sub-par yields. If you assume a conservative 14-times multiple on AEO's fiscal 2019 estimate, it justifies a 10-month price target of $22.40, about 32.5% above its Jun. 28 closing quote. That number is far from an upper limit. AEO topped out at $23.90 back in 2012 on earnings per share of just $1.39. It hit $29.90 last year and peaked at $24.12 as recently as May 3. Independent research firm Morningstar is in general agreement. They rate AEO as a 4-star-out-of-5 buy. Morningstar deigns to provide year-ahead price targets. They do, however, show present day fair value estimates for each stock they cover. For AEO that number sits at $19.52, around 15.5% above its current price. That ultra-conservative estimate is based on the shares fetching a way-below-average price-to-earnings of just 11.2-times forward earnings. Owning AEO outright should provide substantial total returns over the coming six, 12 and 24 months. Option-savvy traders might make even better returns by setting up buy/write combinations using a Jan. 15, 2021 expiration date. Buy/writes involve purchasing shares of a promising underlying stock, while selling covered calls plus naked puts. Actual bid-ask prices for AEO and its January 2021 options are shown below, reflecting premiums with the stock at $16.90. Buy/writes can be done with as little as a 100-share lot and single call and put contracts. The numbers below show the dollars involved on 1,000-shares and 10 each of the option contracts. The generous option premiums received reduce the cash outlay needed to purchase the long stock position. Since both the calls and puts are at identical $20 strikes, there are just two possible outcomes if the trades are held right through expiration. At 4 p.m. on Jan. 15, 2021, AEO will either be $20 or higher, or below $20. Achieving the best-case scenario requires an 18.4% move up from the trade inception price. That appears the most likely outcome based on my analysis of what AEO is really worth. If that occurs, we will have turned a modest gain into better-than-133% in total return. Due to the 1.556 year trade duration, the annualized rate would drop to a still stunning 85.5%. How cool is that? Outright buyers of AEO shares would need to see AEO reach about $38 by Jan. 15, 2021, to net the same 133% sans options. Future stock market action can never be guaranteed. What happens if AEO disappoints and remains below $20 on Jan. 15, 2021? Those pesky puts would be exercised, requiring an additional cash outlay. You'd end up with 2,000 AEO shares at an average price of $14.01. Based on American Eagle's actual trading history, though, that shouldn't be scary. Owning AEO near $14 would have been a winning position 100% of the time dating back to well before the start of 2018. Risk/reward on the buy/write combination is skewed hugely in favor of extreme profitability. It appears unlikely to result in a loss. Buy some AEO shares, set up a buy-write combination trade or consider doing both.

Let American Eagle Soar

American Eagle Outfitters continues to prosper in a tough industry, so buy some shares or set up a buy-write combination trade, or both.

Columnist Conversation

Positive Earnings Surprise From EBIX

This Weekend on Real Money

Big Earnings Beat From Interface (TILE)

COLUMNIST TWEETS

Please Join or Log In to manage and receive alerts.