Are Investors Concerned With What's Going On At Gem Diamonds (LON:GEMD)?

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. Basically the company is earning less on its investments and it is also reducing its total assets. Having said that, after a brief look, Gem Diamonds (LON:GEMD) we aren't filled with optimism, but let's investigate further.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Gem Diamonds is:

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

0.047 = US$14m ÷ (US$334m - US$44m) (Based on the trailing twelve months to June 2020).

Thus, Gem Diamonds has an ROCE of 4.7%. In absolute terms, that's a low return and it also under-performs the Metals and Mining industry average of 14%.

Check out our latest analysis for Gem Diamonds

In the above chart we have measured Gem Diamonds' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Gem Diamonds here for free.

What Can We Tell From Gem Diamonds' ROCE Trend?

The trend of returns that Gem Diamonds is generating are raising some concerns. To be more specific, today's ROCE was 16% five years ago but has since fallen to 4.7%. In addition to that, Gem Diamonds is now employing 37% less capital than it was five years ago. The fact that both are shrinking is an indication that the business is going through some tough times. If these underlying trends continue, we wouldn't be too optimistic going forward.

In Conclusion...

To see Gem Diamonds reducing the capital employed in the business in tandem with diminishing returns, is concerning. It should come as no surprise then that the stock has fallen 65% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing to note, we've identified 3 warning signs with Gem Diamonds and understanding these should be part of your investment process.

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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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