Gem Diamonds' (LON:GEMD) Returns On Capital Not Reflecting Well On The Business

What financial metrics can indicate to us that a company is maturing or even in decline? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. In light of that, from a first glance at Gem Diamonds (LON:GEMD), we've spotted some signs that it could be struggling, so let's investigate.

Return On Capital Employed (ROCE): What is it?

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. The formula for this calculation on Gem Diamonds is:

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

0.13 = US$47m ÷ (US$414m - US$61m) (Based on the trailing twelve months to December 2020).

Therefore, Gem Diamonds has an ROCE of 13%. That's a relatively normal return on capital, and it's around the 14% generated by the Metals and Mining industry.

See 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, you can check out the forecasts from the analysts covering Gem Diamonds here for free.

How Are Returns Trending?

We are a bit worried about the trend of returns on capital at Gem Diamonds. To be more specific, the ROCE was 21% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Gem Diamonds to turn into a multi-bagger.

The Bottom Line

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Long term shareholders who've owned the stock over the last five years have experienced a 48% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Gem Diamonds (of which 1 doesn't sit too well with us!) that you should know about.

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. 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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