Returns On Capital At Gem Diamonds (LON:GEMD) Have Stalled

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Gem Diamonds (LON:GEMD) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What is 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. To calculate this metric for Gem Diamonds, this is the formula:

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

0.18 = US$69m ÷ (US$423m - US$43m) (Based on the trailing twelve months to June 2021).

Thus, Gem Diamonds has an ROCE of 18%. In absolute terms, that's a satisfactory return, but compared to the Metals and Mining industry average of 15% it's much better.

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

How Are Returns Trending?

There hasn't been much to report for Gem Diamonds' returns and its level of capital employed because both metrics have been steady for the past five years. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. So unless we see a substantial change at Gem Diamonds in terms of ROCE and additional investments being made, we wouldn't hold our breath on it being a multi-bagger.

What We Can Learn From Gem Diamonds' ROCE

In summary, Gem Diamonds isn't compounding its earnings but is generating stable returns on the same amount of capital employed. And in the last five years, the stock has given away 41% so the market doesn't look too hopeful on these trends strengthening any time soon. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

One final note, you should learn about the 2 warning signs we've spotted with Gem Diamonds (including 1 which is concerning) .

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.