The Business of Value Investing.pdf

120 The Business of Value Investing

equity risk premium from Wal - Mart leading to a lower cost of equity

for Wal - Mart.

Let ’ s examine a simple ROIC calculation for American Eagle

Outfi tters, a specialty retailer. Table 6.6 looks at the numbers for

the fi scal year 2008.

ROIC  Return/Invested Capital

Return  ( 1  0.37 )  ( 297 )  $ 187

Invested Capital  ( 1 , 963  473 )  ( 327 )  $ 1 , 163

ROIC  $ 187 / $ 1 , 163  16 %

American Eagle ’ s 2007 ROIC was a very respectable 16 percent.

In 2008, the company had no debt, so its cost of debt was zero. As

for the cost of equity, with the risk - free rate around 3 to 4 percent,

assigning an equity risk premium of 10 percent still suggests that

American Eagle is indeed delivering value in the atmosphere of

one of the worst retail environments in decades. One year is cer-

tainly not indicative of long - term value creation, but in years past

American Eagle generated equally impressive returns on invested

capital. While impressive, American Eagle ’ s ROIC is down from

the 28 percent it earned in 2007. If the retail environment remains

choked by the cautious U.S. consumer, such impressive fi gures may

be a thing of the past, at least over the next few years.

When a company has no debt, the return on equity (ROE) can

be just as meaningful as ROIC. In the next section, we see how an

Table 6.6 American Eagle Outfitters ( NYSE: AEO )

Metric Value ( $ millions)

Earnings before interest and taxes $ 297

Total assets $ 1,963

Cash $ 473

Accounts payable $ 327

Tax rate 37%

Source: Yahoo! Finance.

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