If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So when we looked at Tredegar (NYSE:TG) and its trend of ROCE, we really liked what we saw.
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 Tredegar is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.18 = US$70m ÷ (US$523m - US$138m) (Based on the trailing twelve months to March 2021).
Thus, Tredegar has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 8.4% generated by the Chemicals industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Tredegar's ROCE against it's prior returns. If you're interested in investigating Tredegar's past further, check out this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For Tredegar Tell Us?
You'd find it hard not to be impressed with the ROCE trend at Tredegar. The data shows that returns on capital have increased by 86% over the trailing five years. That's a very favorable trend because this means that the company is earning more per dollar of capital that's being employed. Interestingly, the business may be becoming more efficient because it's applying 27% less capital than it was five years ago. If this trend continues, the business might be getting more efficient but it's shrinking in terms of total assets.
The Bottom Line
In summary, it's great to see that Tredegar has been able to turn things around and earn higher returns on lower amounts of capital. Considering the stock has delivered 16% to its stockholders over the last five years, it may be fair to think that investors aren't fully aware of the promising trends yet. So with that in mind, we think the stock deserves further research.
One more thing to note, we've identified 3 warning signs with Tredegar and understanding them should be part of your investment process.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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