The Returns On Capital At Trex Company (NYSE:TREX) Don't Inspire Confidence

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Looking at Trex Company (NYSE:TREX), it does have a high ROCE right now, but lets see how returns are trending.

Return On Capital Employed (ROCE): What is it?

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)

0.42 = US$352m ÷ (US$972m - US$143m) (Based on the trailing twelve months to March 2022).

Therefore, Trex Company has an ROCE of 42%. 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 to see what analysts are forecasting going forward, you should check out our free report for Trex Company.

The Trend Of ROCE

When we looked at the ROCE trend at Trex Company, we didn't gain much confidence. While it's comforting that the ROCE is high, five years ago it was 56%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Trex Company has done well to pay down its current liabilities to 15% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Trex Company is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 199% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

If you'd like to know about the risks facing Trex Company, we've discovered 1 warning sign that you should be aware of.

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.

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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.