Lucara Diamond's (TSE:LUC) Returns On Capital Not Reflecting Well On The Business

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Lucara Diamond (TSE:LUC), it didn't seem to tick all of these boxes.

What Is 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. Analysts use this formula to calculate it for Lucara Diamond:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.075 = US$35m ÷ (US$549m - US$87m) (Based on the trailing twelve months to June 2023).

Therefore, Lucara Diamond has an ROCE of 7.5%. On its own that's a low return, but compared to the average of 2.5% generated by the Metals and Mining industry, it's much better.

View our latest analysis for Lucara Diamond

Above you can see how the current ROCE for Lucara Diamond 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 Lucara Diamond here for free.

So How Is Lucara Diamond's ROCE Trending?

On the surface, the trend of ROCE at Lucara Diamond doesn't inspire confidence. To be more specific, ROCE has fallen from 22% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

The Bottom Line

In summary, we're somewhat concerned by Lucara Diamond's diminishing returns on increasing amounts of capital. This could explain why the stock has sunk a total of 80% in the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing: We've identified 2 warning signs with Lucara Diamond (at least 1 which is significant) , and understanding these would certainly be useful.

While Lucara Diamond may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.