Returns On Capital At Alarm.com Holdings (NASDAQ:ALRM) Paint A Concerning Picture

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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. In light of that, when we looked at Alarm.com Holdings (NASDAQ:ALRM) and its ROCE trend, we weren't exactly thrilled.

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. The formula for this calculation on Alarm.com Holdings is:

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

0.055 = US$64m ÷ (US$1.3b - US$165m) (Based on the trailing twelve months to December 2022).

Therefore, Alarm.com Holdings has an ROCE of 5.5%. 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

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, you can check out the forecasts from the analysts covering Alarm.com Holdings here for free.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Alarm.com Holdings doesn't inspire confidence. To be more specific, ROCE has fallen from 14% 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 15% 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.

One more thing: We've identified 2 warning signs with Alarm.com Holdings (at least 1 which is concerning) , and understanding them would certainly be useful.

While Alarm.com Holdings may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.