Returns On Capital Signal Difficult Times Ahead For Petra Diamonds (LON:PDL)

When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. 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. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. So after glancing at the trends within Petra Diamonds (LON:PDL), we weren't too hopeful.

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 Petra Diamonds is:

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

0.021 = US$20m ÷ (US$1.1b - US$118m) (Based on the trailing twelve months to June 2021).

Therefore, Petra Diamonds has an ROCE of 2.1%. In absolute terms, that's a low return and it also under-performs the Metals and Mining industry average of 18%.

Check out our latest analysis for Petra Diamonds

In the above chart we have measured Petra 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 Petra Diamonds' ROCE Trend?

There is reason to be cautious about Petra Diamonds, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 9.3% that they were earning five years ago. 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 Petra Diamonds to turn into a multi-bagger.

The Key Takeaway

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. This could explain why the stock has sunk a total of 99% in the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Petra Diamonds does have some risks, we noticed 5 warning signs (and 3 which shouldn't be ignored) we think you should know about.

While Petra 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.