Are Alarm.com Holdings, Inc.’s (NASDAQ:ALRM) High Returns Really That Great?
Today we'll evaluate Alarm.com Holdings, Inc. (NASDAQ:ALRM) to determine whether it could have potential as an investment idea. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.
Understanding Return On Capital Employed (ROCE)
ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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.
So, How Do We Calculate ROCE?
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:
0.13 = US$59m ÷ (US$501m - US$57m) (Based on the trailing twelve months to September 2019.)
Therefore, Alarm.com Holdings has an ROCE of 13%.
Check out our latest analysis for Alarm.com Holdings
Does Alarm.com Holdings Have A Good ROCE?
ROCE is commonly used for comparing the performance of similar businesses. Alarm.com Holdings's ROCE appears to be substantially greater than the 9.4% average in the Software industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. 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.
The image below shows how Alarm.com Holdings's ROCE compares to its industry, and you can click it to see more detail on its past growth.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Alarm.com Holdings.
What Are Current Liabilities, And How Do They Affect Alarm.com Holdings's ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counter this, investors can check if a company has high current liabilities relative to total assets.
Alarm.com Holdings has total assets of US$501m and current liabilities of US$57m. As a result, its current liabilities are equal to approximately 11% 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. Alarm.com Holdings looks strong on this analysis, but there are plenty of other companies that could be a good opportunity . Here is a free list of companies growing earnings rapidly.
I will like Alarm.com Holdings better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
