Capital Allocation Trends At Lypsa Gems & Jewellery (NSE:LYPSAGEMS) Aren't Ideal

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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 we looked into Lypsa Gems & Jewellery (NSE:LYPSAGEMS), the trends above didn't look too great.

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 Lypsa Gems & Jewellery, this is the formula:

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

0.00071 = ₹763k ÷ (₹2.9b - ₹1.8b) (Based on the trailing twelve months to December 2022).

Thus, Lypsa Gems & Jewellery has an ROCE of 0.07%. In absolute terms, that's a low return and it also under-performs the Luxury industry average of 12%.

Check out our latest analysis for Lypsa Gems & Jewellery

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Lypsa Gems & Jewellery's past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

In terms of Lypsa Gems & Jewellery's historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 27% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Lypsa Gems & Jewellery to turn into a multi-bagger.

Another thing to note, Lypsa Gems & Jewellery has a high ratio of current liabilities to total assets of 63%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

In Conclusion...

In summary, it's unfortunate that Lypsa Gems & Jewellery is generating lower returns from the same amount of capital. Unsurprisingly then, the stock has dived 79% over the last five years, so investors are recognizing these changes and don't like the company's prospects. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you'd like to know more about Lypsa Gems & Jewellery, we've spotted 3 warning signs, and 2 of them are significant.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.