If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So, when we ran our eye over Trex Company's (NYSE:TREX) trend of ROCE, we really liked what we saw.
Understanding 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. 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)
0.39 = US$220m ÷ (US$671m - US$112m) (Based on the trailing twelve months to June 2020).
Therefore, Trex Company has an ROCE of 39%. That's a fantastic return and not only that, it outpaces the average of 15% earned by companies in a similar industry.
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.
The Trend Of ROCE
In terms of Trex Company's history of ROCE, it's quite impressive. The company has employed 208% more capital in the last five years, and the returns on that capital have remained stable at 39%. With returns that high, it's great that the business can continually reinvest its money at such appealing rates of return. You'll see this when looking at well operated businesses or favorable business models.On a side note, Trex Company has done well to reduce current liabilities to 17% of total assets over the last five years. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously.
What We Can Learn From Trex Company's ROCE
In short, we'd argue Trex Company has the makings of a multi-bagger since its been able to compound its capital at very profitable rates of return. And long term investors would be thrilled with the 617% return they've received over the last five years. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.
Trex Company does have some risks though, and we've spotted 1 warning sign for Trex Company that you might be interested in.
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. 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.
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