Capital Allocation Trends At Trex Company (NYSE:TREX) Aren't Ideal

There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. Having said that, while the ROCE is currently high for Trex Company (NYSE:TREX), we aren't jumping out of our chairs because returns are decreasing.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Trex Company:

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

0.41 = US$262m ÷ (US$934m - US$291m) (Based on the trailing twelve months to December 2022).

Therefore, Trex Company has an ROCE of 41%. In absolute terms that's a great return and it's even better than the Building industry average of 14%.

Check out 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'd like, you can check out the forecasts from the analysts covering Trex Company here for free.

So How Is Trex Company's ROCE Trending?

When we looked at the ROCE trend at Trex Company, we didn't gain much confidence. To be more specific, while the ROCE is still high, it's fallen from 54% where it was five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 31%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

The Bottom Line

In summary, Trex Company is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Although the market must be expecting these trends to improve because the stock has gained 75% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

If you'd like to know more about Trex Company, we've spotted 2 warning signs, and 1 of them doesn't sit too well with us.

Trex Company is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.