Gem Diamonds (LON:GEMD) Is Finding It Tricky To Allocate Its Capital

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. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. So after glancing at the trends within Gem Diamonds (LON:GEMD), we weren't too hopeful.

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Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Gem Diamonds:

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

0.047 = US$15m ÷ (US$349m - US$25m) (Based on the trailing twelve months to December 2024).

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 11%.

Check out our latest analysis for Gem Diamonds

Above you can see how the current ROCE for Gem Diamonds compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Gem Diamonds .

What Does the ROCE Trend For Gem Diamonds Tell Us?

In terms of Gem Diamonds' historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 6.7% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Gem Diamonds becoming one if things continue as they have.

The Bottom Line On Gem Diamonds' ROCE

In summary, it's unfortunate that Gem Diamonds is generating lower returns from the same amount of capital. We expect this has contributed to the stock plummeting 75% during the last five years. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Gem Diamonds does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those makes us a bit uncomfortable...

While Gem Diamonds isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.