If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? 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 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)

0.065 = US$20m ÷ (US$338m - US$21m) (Based on the trailing twelve months to June 2023).

Therefore, Gem Diamonds has an ROCE of 6.5%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 11%.

See our latest analysis for Gem Diamonds

Above you can see how the current ROCE for Gem Diamonds compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Gem Diamonds here for free.

What Can We Tell From Gem Diamonds' ROCE Trend?

In terms of Gem Diamonds' 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. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Gem Diamonds becoming one if things continue as they have.

The Key Takeaway

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Unsurprisingly then, the stock has dived 88% over the last five years, so investors are recognizing these changes and don't like the company's prospects. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.