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

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Looking at Trex Company (NYSE:TREX), it does have a high ROCE right now, but lets see how returns are trending.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Trex Company is:

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

0.33 = US$224m ÷ (US$1.1b - US$448m) (Based on the trailing twelve months to March 2023).

Therefore, Trex Company has an ROCE of 33%. In absolute terms that's a great return and it's even better than the Building industry average of 15%.

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 to see what analysts are forecasting going forward, you should check out our free report for Trex Company.

SWOT Analysis for Trex Company

How Are Returns Trending?

In terms of Trex Company's historical ROCE movements, the trend isn't fantastic. While it's comforting that the ROCE is high, five years ago it was 51%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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.

The Key Takeaway

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. Yet despite these concerning fundamentals, the stock has performed strongly with a 97% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One more thing to note, we've identified 2 warning signs with Trex Company and understanding these should be part of your investment process.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.