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. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. So after we looked into Gem Diamonds (LON:GEMD), the trends above didn't look too great.

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. 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)

0.04 = US$13m ÷ (US$383m - US$46m) (Based on the trailing twelve months to June 2024).

Thus, Gem Diamonds has an ROCE of 4.0%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 8.8%.

View 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'd like, you can check out the forecasts from the analysts covering Gem Diamonds for free.

The Trend Of ROCE

We are a bit worried about the trend of returns on capital at Gem Diamonds. Unfortunately the returns on capital have diminished from the 8.2% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. 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 Gem Diamonds to turn into a multi-bagger.

The Bottom Line

In summary, it's unfortunate that Gem Diamonds is generating lower returns from the same amount of capital. We expect this has contributed to the stock plummeting 83% during the last five years. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you want to continue researching Gem Diamonds, you might be interested to know about the 3 warning signs that our analysis has discovered.

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.