Stock Analysis

The Returns On Capital At Petra Diamonds (LON:PDL) Don't Inspire Confidence

LSE:PDL
Source: Shutterstock

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. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base 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. So after glancing at the trends within Petra Diamonds (LON:PDL), we weren't too hopeful.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Petra Diamonds:

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

0.083 = US$84m ÷ (US$1.1b - US$80m) (Based on the trailing twelve months to December 2021).

Therefore, Petra Diamonds has an ROCE of 8.3%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 12%.

See our latest analysis for Petra Diamonds

roce
LSE:PDL Return on Capital Employed September 13th 2022

Above you can see how the current ROCE for Petra Diamonds compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For Petra Diamonds Tell Us?

The trend of ROCE at Petra Diamonds is showing some signs of weakness. To be more specific, today's ROCE was 11% five years ago but has since fallen to 8.3%. On top of that, the business is utilizing 21% less capital within its operations. The fact that both are shrinking is an indication that the business is going through some tough times. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

What We Can Learn From Petra Diamonds' ROCE

In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. We expect this has contributed to the stock plummeting 97% during the last five years. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Petra Diamonds (of which 1 shouldn't be ignored!) that 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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Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

About LSE:PDL

Petra Diamonds

Engages in the mining, processing, sorting, and sale of rough diamonds in South Africa and Tanzania.

Undervalued with moderate growth potential.

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