What a brutal six months it’s been for Trex. The stock has dropped 35.2% and now trades at $34.65, rattling many shareholders. This was partly driven by its softer quarterly results and might have investors contemplating their next move.
Is there a buying opportunity in Trex, or does it present a risk to your portfolio? See what our analysts have to say in our full research report, it’s free for active Edge members.
Why Do We Think Trex Will Underperform?
Even though the stock has become cheaper, we don't have much confidence in Trex. Here are three reasons you should be careful with TREX and a stock we'd rather own.
1. Slow Organic Growth Suggests Waning Demand In Core Business
In addition to reported revenue, organic revenue is a useful data point for analyzing Home Construction Materials companies. This metric gives visibility into Trex’s core business because it excludes one-time events such as mergers, acquisitions, and divestitures along with foreign currency fluctuations - non-fundamental factors that can manipulate the income statement.
Over the last two years, Trex’s organic revenue averaged 5.9% year-on-year growth. This performance was underwhelming and suggests it may need to improve its products, pricing, or go-to-market strategy, which can add an extra layer of complexity to its operations. 
2. Free Cash Flow Margin Dropping
If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.
As you can see below, Trex’s margin dropped by 6.1 percentage points over the last five years. If its declines continue, it could signal increasing investment needs and capital intensity. Trex’s free cash flow margin for the trailing 12 months was 2%.
3. New Investments Fail to Bear Fruit as ROIC Declines
A company’s ROIC, or return on invested capital, shows how much operating profit it makes compared to the money it has raised (debt and equity).
We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Over the last few years, Trex’s ROIC has unfortunately decreased significantly. We like what management has done in the past, but its declining returns are perhaps a symptom of fewer profitable growth opportunities.
Final Judgment
Trex doesn’t pass our quality test. After the recent drawdown, the stock trades at 22.2× forward P/E (or $34.65 per share). At this valuation, there’s a lot of good news priced in - we think there are better stocks to buy right now. We’d suggest looking at one of Charlie Munger’s all-time favorite businesses.
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