If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. 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)

0.054 = US$60m ÷ (US$1.3b - US$141m) (Based on the trailing twelve months to June 2022).

So, Alarm.com Holdings has an ROCE of 5.4%. In absolute terms, that's a low return and it also under-performs the Software industry average of 10%.

View our latest analysis for Alarm.com Holdings

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 to see what analysts are forecasting going forward, you should check out our free report for Alarm.com Holdings.

What Can We Tell From Alarm.com Holdings' ROCE Trend?

When we looked at the ROCE trend at Alarm.com Holdings, we didn't gain much confidence. Around five years ago the returns on capital were 13%, but since then they've fallen to 5.4%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

What We Can Learn From Alarm.com Holdings' ROCE

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. And the stock has followed suit returning a meaningful 67% to shareholders over the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.

On a final note, we've found 2 warning signs for Alarm.com Holdings that we think you should be aware of.

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.