The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to begin learning the link between Tredegar Corporation (NYSE:TG)’s return fundamentals and stock market performance.
Purchasing Tredegar gives you an ownership stake in the company. This share represents a portion of capital used by the company to operate the business, and it is important the company is able to use the capital base efficiently to create adequate cash flows for you as an investor. This is because the actual cash flow generated by the business dictates the potential for income (dividends) and capital appreciation (price increases), which are the two ways to achieve positive returns when buying a stock. To understand Tredegar’s capital returns we will look at a useful metric called return on capital employed. This will tell us if the company is growing your capital and placing you in good stead to sell your shares at a profit.
ROCE: Explanation and Calculation
Choosing to invest in Tredegar comes at the cost of investing in another potentially favourable company. Therefore all else aside, your investment in a certain company represents a vote of confidence that the money used to buy the stock will grow larger than if invested elsewhere. So the business’ ability to grow the size of your capital is very important and can be assessed by comparing the return on capital you can get on your investment with a hurdle rate that depends on the other return possibilities you can identify. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if Tredegar is good at growing investor capital. I have calculated Tredegar’s ROCE for you below:
ROCE Calculation for TG
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = US$55m ÷ (US$691m – US$173m) = 12%
The calculation above shows that TG’s earnings were 12% of capital employed. This makes Tredegar slightly mediocre when compared to a robust 15% ROCE yardstick. So if this rate continues in to the future, investor capital will be able to compound over time, but still may be missing out on some potential growth elsewhere.
Then why have investors invested?
Tredegar’s relatively poor ROCE is tied to the movement in two factors that change over time: earnings and capital requirements. At the moment Tredegar is in an adverse position, but this can change if these factors improve. Therefore, investors need to understand the trend of the inputs in the formula above, so that they can see if there is an opportunity to invest. Three years ago, TG’s ROCE was 8.9%, which means the company’s capital returns have improved. In this time, earnings have actually fallen from US$57m to US$55m, but the use of capital has fallen further due to a fall in total assets employed and greater use of borrowed capital (increase in current liabilities) , which suggests investor’s ROCE has risen because the company requires less capital to create earnings despite the previous decline in EBT.
Although Tredegar’s ROCE is currently below the acceptable benchmark, the company has triggered an upward trend over the recent past which could signal an opportunity for a solid return on investment in the long term. Before making any decisions, ROCE does not tell the whole picture so you need to pay attention to other fundamentals like future prospects and valuation to determine if an opportunity exists that isn’t made apparent by looking at past data. Tredegar’s fundamentals can be explored with the links I’ve provided below if you are interested, otherwise you can start looking at other high-performing stocks.
- Future Outlook: What are well-informed industry analysts predicting for TG’s future growth? Take a look at our free research report of analyst consensus for TG’s outlook.
- Valuation: What is TG worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether TG is currently undervalued by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.