I Was Right About American Eagle Outfitters

Last month, I made a CAPScall on American Eagle Outfitters (NYSE: AEO  ) , predicting a downfall in profits within the next six months to a year brought about by heavy markdowns on the mountain of inventory it had accumulated. Now, just three weeks later, my prediction has come true.

I was expecting a sharp, fast decline in the stock price brought on by disappointing news in the quarterly report in March. The company has done me a favor by releasing the preliminary sales figures for the holiday season and revising its earnings-per-share guidance from a range of $0.40 to $0.44 to a range of $0.33 to $0.35, down about 20%.

The revision seems to have surprised the market, but not me. At the end of the third quarter, going into the holiday season, American Eagle carried inventories that were 40% higher than the previous year. Trying to pass through that mountain of inventory at a time when retail stores are offering deep discounts on everything is more treacherous than trying to pass through the Misty Mountains by way of Caradhras.

Even with 15% higher sales during November and December, management still found itself forced to make "a strategic decision to take a more aggressive promotional stance." The company claims that although the strategy hurt margins, it improved market share, but I'm doubtful.

Zumiez (Nasdaq: ZUMZ  ) and Limited Brands (NYSE: LTD  ) also reported big increases in same-store sales but revised their earnings guidance higher. Even archrival Aeropostale (NYSE: ARO  ) reported dismal sales for the holidays but pleased the market by reiterating its earnings guidance.

American Eagle's stock is starting to recover from its steep drop already, so I'm going to take my modest but quick profit and end my CAPScall. Rest assured, though, that I'll be keeping a close eye on the company to see whether the situation changes or whether the stock gets ripe for another underperform call. Add American Eagle Outfitters to My Watchlist to stay updated on if or when that happens.