Why Alarm.com Should Be on Your Radar

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As the world becomes more and more connected through the internet and smart devices, many companies are taking off by updating old technology.

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In this clip from Industry Focus: Tech, host Dylan Lewis and Motley Fool contributor Todd Campbell dive into Alarm.com (NASDAQ: ALRM), which is bringing home security into the digital age. Listen in to find out how Alarm.com works, how the company is growing its market share, and how the Internet of Things is changing everything inside the home. They also talk, among other things, about some of the most exciting growth prospects that Alarm.com is cashing in on and a few of the biggest risks that investors need to be aware of before buying in.

A full transcript follows the video.

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This video was recorded on Sept. 22, 2017.

Dylan Lewis: Why don't we start out with Alarm.com?

Todd Campbell: Alarm.com should interest or potentially excite investors, because they're taking an industry that's been around for a long time, home security, and they're actually bringing it forward into the 21st century, making it far more relevant to the way we live our connected lives today.

Lewis: And how exactly are they doing that?

Campbell: Think about, what did security look like in the past? It was all point-in-time security. Someone breaks a glass window or busts in through the door, or you're recording on some grainy black-and-white video your front door and having to go back and try to figure out who may have knocked on it at 2 p.m. by watching six hours of tape. It was obviously not a very efficient way to monitor the security of a home. If something happened, you would get a phone call that would go out automatically to the police or the fire department. But it really didn't provide you with a lot of useful insight that you could use to manage your household. And what Alarm.com is doing is, they're saying, "What happens if we allow for real-time monitoring of the home and the systems around it and inside it? What kind of insight would that give the homeowner, that they can then use to improve their day-to-day life?"

So they came up with an app that plays nice with all of these Internet of Things connected devices that we're increasingly installing in our homes. And that app allows you to lock or unlock your doors, arm or disarm your security system, or record in real time on high-def video what's going on in and around your house, control your lighting, control your thermostat, do all of these Jetson-like things that for the last 40 years we've been hoping our households would end up incorporating.

Lewis: This is an Internet of Things-style company. You mentioned that before. Typically, you think of devices when you hear Internet of Things. But this is really much more of a software company, right?

Campbell: They sell hardware, but it's mostly, they're working with OEMs and third parties and collecting a little bit of a higher-margin end of that from selling the software as a service. I think a lot of people look at companies like this and say, "We're going to disrupt this industry," any industry, "and we're going to do that by going directly to the consumer." Well, Alarm.com, that's how they started out. They said, "What if we take these monitoring and controlling systems and we sell them directly to the consumer?"

What they've soon found out is that a lot of consumers that are early adopters or early inning adopters of this kind of technology, they're relatively wealthy, and they're time constrained, and they're really not going to want to go around their house and unscrew all their light bulbs and screw in new light bulbs and take out thermostats and put in thermostats and take off and put on deadbolts. So they ended up tapping into the current existing security companies that exist in all around America and offering their app to them, to private label or white label, or not, to be used alongside the stuff they were already selling, installing, and maintaining for these different homeowners. And it's worked out very well for them. They've had tremendous growth as a result, in terms of the number of subscribers, the number of sales, and the company's profitability.

Lewis: Yeah. When you think about things that you want to have work correctly, I think home security is definitely one of them. I trust a professional to install something like that far more than I trust myself.

Campbell: These systems are complex. I don't know to what degree you've installed any of these things in your own home, but I've gone through and I've done a couple of little things here and there, and you're trying to get them all to communicate to one another, and it's like, oh my God.

Lewis: You mentioned the market opportunity, Todd. I think the home security market might not be something people are super familiar with. What does that look like? And what kind of presence does Alarm.com currently have?

Campbell: I was a little bit surprised. This number shocked me a little bit. There are 22 million homes in America that have security systems in place. Twenty-two million. That seems like a lot to me. What's really interesting about that is, of those 22 million, not very many, 30%-40% of them, I'll call smart homes. But how smart are these homes really? We're still very early in this whole smart-home movement. Right now, we're really controlling the temperature, the climate, that kind of thing. It's not as smart as it will be in 10 years. But a very small percentage of those 22 million are smart homes, but Alarm is already working with about 5 million of these homeowners, which is pretty impressive to me, given the fact that they were working with 1 million back in 2012.

Lewis: That smart-home stat, there are a lot of different things that can qualify as a smart home. Having something like Nest, it could be a smart-home product, or it could be kind of a more integrated, full security system, like some of the stuff that Alarm.com partners with.

Campbell: I was kind of hinting at this earlier. You have all these players like Nest and Z-wave and all these other things out there, and the idea is, you've got all these different devices. How do you get them all to work and play nicely together? Everybody's got an Echo inside their house now, and they're using -- I won't use the word, because our listeners tell us that it actually triggers it to turn on -- the name of the device when we ask it to do something.

Lewis: That's very courteous, Todd.

Campbell: Yes. I like to try to help out our listeners whenever possible. But you're able now to access Alarm.com through your Echo to be able to do things like say, "Dim my lights 30%." Or, "Hey, I'm a little chilly. Can I get the air conditioning to drop down another 2 degrees?" Or something like that. So it's really become far more than just, "I'm securing your home, and if someone breaks a window I'm calling the police." You're now able to use all of this real-time data that's being collected and discover all sorts of information about what's going on around your home. I don't know about you -- I may have snuck out once or twice when I was a kid.

Lewis: Of course, yeah.

Campbell: Alarm.com is going to make that a lot more difficult for the teens of today.

Lewis: Parents, take note. Todd, what are some of the numbers like for this company? We talk about how small-cap companies tend to be big growth opportunities. How do the financials look?

Campbell: We're talking about a fast-growing company. Revenue on a compounded annual basis, it's grown about 28% since 2012. In the second quarter, sales were up 33.5% to $86 million. It's not a Goliath company. It's a small-cap company. But it's growing rapidly. If you look at the way that their revenue breaks down, Dylan, most of it is coming from higher-margin software, gets about 40% of its sales from that, or a little bit more. And its guidance for 2017 is for 25% year-over-year growth -- nothing to complain about there; $326 million, at least, in sales. And about $1.00 in earnings per share, too. So it's profitable. So you have a company that's growing double digits, generating profit for investors, in a really, I think, attractive market.

Lewis: And something that I think is kind of a major trait of most small-cap stocks is, they don't necessarily trade for kind of "reasonable," quote-unquote, valuations on a P/E or price-to-sales basis. At a $2 billion market cap, this is obviously a company that's priced for growth. But when you're looking at what might be in front of it, that's what you're paying for, right?

Campbell: You're going to end up paying, typically, on a price-to-sales multiple, you're going to pay up 7 to 12 times sales for these fast growers. The thing that you have to remember, though, is that if you get a company that's growing 20% annually, you know, the revenue is going to double in five years. So, you really do have to think about the potential, how big the market could be, and then figure out what a fair value is. If you say, "OK, you know, maybe it's worth 5 times sales in five years, and sales are going to double, maybe it's worth $3 billion, or $4 billion." Some of these are puts and takes that you're going to have to consider when you consider how big the market opportunity is versus how much you're willing to pay up to buy the stock.

Lewis: And that plays into the overall volatility that we see with a lot of these companies. It's very difficult to forecast out what a market might look like, and a lot of people have different estimates and different expectations for what a company could grow into. And because of that, as a company reports earnings, maybe the picture pans out as they expect, maybe it doesn't, there will be major corrections with the stock price accordingly.

Campbell: Yeah. You have risks. You have competitors out there who have been in the market for years and years and years, like ADT, etc. And they're not going to just give up this marketplace easily. So competition could increase. You've got technology evolving so rapidly, and who knows, how is Amazon going to try? Could they, at some point, leverage Echo to try and home in on this market? Who knows. So there are some risks. Investors need to remember that.

Dylan Lewis owns shares of Amazon. Todd Campbell owns shares of Amazon. The Motley Fool owns shares of and recommends Amazon. The Motley Fool recommends Alarm.com Holdings. The Motley Fool has a disclosure policy.