There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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)
0.12 = US$66m ÷ (US$663m - US$93m) (Based on the trailing twelve months to June 2020).
Therefore, Alarm.com Holdings has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Software industry average of 9.4% it's much better.
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
We weren't thrilled with the trend because Alarm.com Holdings' ROCE has reduced by 51% over the last five years, while the business employed 535% more capital. That being said, Alarm.com Holdings raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Alarm.com Holdings' earnings and if they change as a result from the capital raise.
On a side note, Alarm.com Holdings has done well to pay down its current liabilities to 14% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Bottom Line
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. And long term investors must be optimistic going forward because the stock has returned a huge 377% to shareholders in the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.
Alarm.com Holdings could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.
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. 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email email@example.com.