Today we’ll look at Alarm.com Holdings, Inc. (NASDAQ:ALRM) and reflect on its potential as an investment. Specifically, we’re going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
Firstly, we’ll go over how we calculate ROCE. Next, we’ll compare it to others in its industry. Last but not least, we’ll look at what impact its current liabilities have on its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since ‘No two businesses are exactly alike.’
How Do You Calculate Return On Capital Employed?
The formula for calculating the return on capital employed is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
Or for Alarm.com Holdings:
0.17 = US$46m ÷ (US$427m – US$73m) (Based on the trailing twelve months to September 2018.)
So, Alarm.com Holdings has an ROCE of 17%.
Is Alarm.com Holdings’s ROCE Good?
One way to assess ROCE is to compare similar companies. In our analysis, Alarm.com Holdings’s ROCE is meaningfully higher than the 9.4% average in the Software industry. I think that’s good to see, since it implies the company is better than other companies at making the most of its capital. Separate from Alarm.com Holdings’s performance relative to its industry, its ROCE in absolute terms looks satisfactory, and it may be worth researching in more depth.
As we can see, Alarm.com Holdings currently has an ROCE of 17% compared to its ROCE 3 years ago, which was 13%. This makes us wonder if the company is improving.
When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. ROCE is only a point-in-time measure. Since the future is so important for investors, you should check out our free report on analyst forecasts for Alarm.com Holdings.
Alarm.com Holdings’s Current Liabilities And Their Impact On Its ROCE
Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Alarm.com Holdings has total assets of US$427m and current liabilities of US$73m. As a result, its current liabilities are equal to approximately 17% of its total assets. Low current liabilities are not boosting the ROCE too much.
Our Take On Alarm.com Holdings’s ROCE
Overall, Alarm.com Holdings has a decent ROCE and could be worthy of further research. Of course you might be able to find a better stock than Alarm.com Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
For those who like to find winning investments this free list of growing companies with recent insider purchasing, could be just the ticket.
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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.