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If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Alarm.com Holdings (NASDAQ:ALRM) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Return On Capital Employed (ROCE): What is it?
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. 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)
0.072 = US$78m ÷ (US$1.2b - US$102m) (Based on the trailing twelve months to September 2021).
Therefore, Alarm.com Holdings has an ROCE of 7.2%. In absolute terms, that's a low return and it also under-performs the Software industry average of 11%.
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'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 16% 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. If these investments prove successful, this can bode very well for long term stock performance.
Our Take On Alarm.com Holdings' ROCE
While returns have fallen for Alarm.com Holdings in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has done incredibly well with a 194% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
Alarm.com Holdings does have some risks, we noticed 4 warning signs (and 1 which can't be ignored) we think you should know about.
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.
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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