Returns On Capital Signal Tricky Times Ahead For Trex Company (NYSE:TREX)

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Looking at Trex Company (NYSE:TREX), it does have a high ROCE right now, but lets see how returns are trending.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Trex Company, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.34 = US$278m ÷ (US$997m - US$182m) (Based on the trailing twelve months to September 2023).

Thus, Trex Company has an ROCE of 34%. In absolute terms that's a great return and it's even better than the Building industry average of 16%.

See our latest analysis for Trex Company

Above you can see how the current ROCE for Trex Company compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Trex Company .

What Can We Tell From Trex Company's ROCE Trend?

On the surface, the trend of ROCE at Trex Company doesn't inspire confidence. While it's comforting that the ROCE is high, five years ago it was 47%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

In Conclusion...

From the above analysis, we find it rather worrisome that returns on capital and sales for Trex Company have fallen, meanwhile the business is employing more capital than it was five years ago. Since the stock has skyrocketed 148% over the last five years, it looks like investors have high expectations of the stock. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

Story continues

If you're still interested in Trex Company it's worth checking out our FREE intrinsic value approximation for TREX to see if it's trading at an attractive price in other respects.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.