Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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. 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.

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$66m ÷ (US$1.4b - US$172m) (Based on the trailing twelve months to September 2023).

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 7.7%.

See our latest analysis for Alarm.com Holdings

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

What Does the ROCE Trend For Alarm.com Holdings Tell Us?

In terms of Alarm.com Holdings' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 5.4% from 17% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

Our Take On Alarm.com Holdings' ROCE

In summary, Alarm.com Holdings is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors may be recognizing these trends since the stock has only returned a total of 12% to shareholders over the last five years. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

If you'd like to know about the risks facing Alarm.com Holdings, we've discovered 1 warning sign that you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.