Did you know there are some financial metrics that can provide clues of a potential multi-bagger? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. So while Trex Company (NYSE:TREX) has a high ROCE right now, lets see what we can decipher from how returns are changing.
Return On Capital Employed (ROCE): What Is It?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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)
0.33 = US$276m ÷ (US$933m - US$91m) (Based on the trailing twelve months to December 2023).
Thus, Trex Company has an ROCE of 33%. That's a fantastic return and not only that, it outpaces the average of 17% earned by companies in a similar industry.
In the above chart we have measured Trex Company's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Trex Company .
What Does the ROCE Trend For Trex Company Tell Us?
In terms of Trex Company's historical ROCE movements, the trend isn't fantastic. Historically returns on capital were even higher at 47%, but they have dropped over the last five years. However it looks like Trex Company might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
On a side note, Trex Company has done well to pay down its current liabilities to 9.8% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Bottom Line
To conclude, we've found that Trex Company is reinvesting in the business, but returns have been falling. Yet to long term shareholders the stock has gifted them an incredible 130% return in the last five years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
Like most companies, Trex Company does come with some risks, and we've found 1 warning sign that you should be aware of.
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.