Alarm.com Holdings (NASDAQ:ALRM) May Have Issues Allocating Its Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Alarm.com Holdings (NASDAQ:ALRM) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What Is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Alarm.com Holdings:

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

0.054 = US$60m ÷ (US$1.3b - US$141m) (Based on the trailing twelve months to June 2022).

Therefore, Alarm.com Holdings has an ROCE of 5.4%. Ultimately, that's a low return and it under-performs the Software industry average of 10%.

Our analysis indicates that ALRM is potentially undervalued!

In the above chart we have measured Alarm.com Holdings' 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 Alarm.com Holdings.

What The Trend Of ROCE Can Tell Us

In terms of Alarm.com Holdings' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 13% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Alarm.com Holdings is reinvesting for growth and has higher sales as a result. In light of this, the stock has only gained 25% over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

On a final note, we've found 2 warning signs for Alarm.com Holdings that we think you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.