If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Gem Diamonds (LON:GEMD) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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)

0.14 = US$48m ÷ (US$385m - US$30m) (Based on the trailing twelve months to December 2021).

So, Gem Diamonds has an ROCE of 14%. That's a pretty standard return and it's in line with the industry average of 14%.

Check out 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 to see what analysts are forecasting going forward, you should check out our free report for Gem Diamonds.

What Does the ROCE Trend For Gem Diamonds Tell Us?

In terms of Gem Diamonds' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 14% from 17% five years ago. However it looks like Gem Diamonds might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

The Bottom Line

In summary, Gem Diamonds is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors appear hesitant that the trends will pick up because the stock has fallen 41% in the last five years. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

Gem Diamonds does have some risks though, and we've spotted 2 warning signs for Gem Diamonds that you might be interested in.

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.

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.

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