There Are Reasons To Feel Uneasy About Trex Company's (NYSE:TREX) Returns On Capital

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. 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. 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.

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. 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)

0.28 = US$211m ÷ (US$1.1b - US$323m) (Based on the trailing twelve months to June 2023).

Therefore, Trex Company has an ROCE of 28%. That's a fantastic return and not only that, it outpaces the average of 15% earned by companies in a similar industry.

Check out our latest analysis for Trex Company

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

What Does the ROCE Trend For Trex Company Tell Us?

On the surface, the trend of ROCE at Trex Company doesn't inspire confidence. Historically returns on capital were even higher at 49%, but they have dropped over the last five years. 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.

In Conclusion...

In summary, we're somewhat concerned by Trex Company's diminishing returns on increasing amounts of capital. However the stock has delivered a 79% return to shareholders over the last five years, so investors might be expecting the trends to turn around. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

Trex Company does have some risks though, and we've spotted 1 warning sign for Trex Company that you might be interested in.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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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.