Today we are going to look at Trex Company, Inc. (NYSE:TREX) to see whether it might be an attractive investment prospect. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.
First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. And finally, we'll look at how its current liabilities are impacting its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.'
So, How Do We Calculate ROCE?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Trex Company:
0.35 = US$158m ÷ (US$536m - US$81m) (Based on the trailing twelve months to June 2019.)
Therefore, Trex Company has an ROCE of 35%.
Is Trex Company's ROCE Good?
ROCE can be useful when making comparisons, such as between similar companies. Trex Company's ROCE appears to be substantially greater than the 12% average in the Building industry. I think that's good to see, since it implies the company is better than other companies at making the most of its capital. Putting aside its position relative to its industry for now, in absolute terms, Trex Company's ROCE is currently very good.
Trex Company's current ROCE of 35% is lower than 3 years ago, when the company reported a 65% ROCE. So investors might consider if it has had issues recently. You can see in the image below how Trex Company's ROCE compares to its industry. Click to see more on past growth.
When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. Companies in cyclical industries can be difficult to understand using ROCE, as returns typically look high during boom times, and low during busts. ROCE is, after all, simply a snap shot of a single year. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Trex Company.
Do Trex Company's Current Liabilities Skew Its ROCE?
Current liabilities are short term bills and invoices that need to be paid in 12 months or less. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.
Trex Company has total assets of US$536m and current liabilities of US$81m. Therefore its current liabilities are equivalent to approximately 15% of its total assets. A minimal amount of current liabilities limits the impact on ROCE.
What We Can Learn From Trex Company's ROCE
This is good to see, and with such a high ROCE, Trex Company may be worth a closer look. Trex Company looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
I will like Trex Company better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
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