What happened

Last year, shares of American Eagle Outfitters, Inc. (NYSE:AEO) rebounded from their poor 2016 performance, with investors bidding up shares of the company 24% in 2017, according to data provided by S&P Global Market Intelligence. American Eagle investors were impressed with the company's continued strong financial performance, which includes 11 consecutive quarters of comparable-sales growth.

AEO data by YCharts.

So what

American Eagle Outfitters' comparable-sales success is due to the company's Aerie lingerie brand. Last quarter, the Aerie brand posted a comparable-store increase of 19%. Through October, Aerie was growing year-to-date comps at a 23% rate, only slightly below the 25% it posted in the prior-year's comparable period.

Image Source: Getty Images.

The teen-friendly clothing brand shook off concerns that have plagued other retailers, particularly mall-based apparel retailers. Unfortunately, there's a cost associated with the increases in comparable sales: falling margins. In the last three quarters, American Eagle has seen its gross profit margin fall on a year-on-year basis, as increased promotions and higher shipping costs are rising faster than revenue.

Quarter Ended January 2016 April 2016 July 2016 October 2016 January 2017 April 2017 July 2017 October 2017
Revenue $1,106 $749 $823 $941 $1,097 $762 $845 $960
Cost of revenue $718 $456 $515 $563 $709 $484 $552 $586
Gross profit $388 $293 $307 $378 $389 $278 $293 $375
Gross profit percentage 35.1% 39.1% 37.3% 40.2% 35.5% 36.5% 34.7% 39.1%
Total operating expenses $272 $235 $238 $260 $303 $241 $254 $264
Operating income $116 $59 $69 $118 $86 $37 $39 $111
Operating income percentage 10.5% 7.9% 8.4% 12.5% 7.8% 4.9% 4.6% 11.6%

Dollar figures in millions. Data source: American Eagle Outfitters.

Operating margin, which includes sales, general, and administrative costs, has endured year-on-year decreases for four consecutive quarters. One encouraging sign for operating income is that margin loss appears to be narrowing. In the quarter ended January 2017, operating income percentage decreased 260 basis points on a year-on-year basis -- 7.8% versus 10.5%. In the quarter ended September 2017, the operating margin decreased approximately 90 basis points.

Now what

Even considering American Eagle Outfitters' strong 2017 performance, the company is still cheaply valued. Shares of the company now trade hands at approximately 14 times forward earnings. Compared to the S&P 500's forward price-to-earnings ratio of 19, American Eagle Outfitters should be able to build upon 2017's stock rally if the company can continue to post comparable-store growth and reverse its operation margin declines.

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Jamal Carnette, CFA has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.