Returns Are Gaining Momentum At Gem Diamonds (LON:GEMD)

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So when we looked at Gem Diamonds (LON:GEMD) and its trend of ROCE, we really liked what we saw.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its 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)

0.096 = US$34m ÷ (US$379m - US$26m) (Based on the trailing twelve months to June 2022).

So, Gem Diamonds has an ROCE of 9.6%. In absolute terms, that's a low return but it's around the Metals and Mining industry average of 11%.

See 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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From Gem Diamonds' ROCE Trend?

Gem Diamonds is showing promise given that its ROCE is trending up and to the right. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 56% over the last five years. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.

In Conclusion...

In summary, we're delighted to see that Gem Diamonds has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Astute investors may have an opportunity here because the stock has declined 66% in the last five years. So researching this company further and determining whether or not these trends will continue seems justified.

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

While Gem Diamonds 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.

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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.