Alarm.com Holdings' (NASDAQ:ALRM) Returns On Capital Not Reflecting Well On The Business

What are the early trends we should look for to identify a stock that could multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Alarm.com Holdings (NASDAQ:ALRM), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What Is It?

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 Alarm.com Holdings, this is the formula:

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

0.051 = US$59m ÷ (US$1.3b - US$151m) (Based on the trailing twelve months to September 2022).

Therefore, Alarm.com Holdings has an ROCE of 5.1%. In absolute terms, that's a low return and it also under-performs the Software industry average of 10%.

Check out our latest analysis for Alarm.com Holdings

Above you can see how the current ROCE for Alarm.com Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For Alarm.com Holdings Tell Us?

When we looked at the ROCE trend at Alarm.com Holdings, we didn't gain much confidence. Around five years ago the returns on capital were 13%, but since then they've fallen to 5.1%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

In Conclusion...

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Alarm.com Holdings. These trends are starting to be recognized by investors since the stock has delivered a 37% gain to shareholders who've held 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.

If you want to know some of the risks facing Alarm.com Holdings we've found 3 warning signs (1 is potentially serious!) that you should be aware of before investing here.

While Alarm.com Holdings 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.