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Cummins Inc.'s (NYSE:CMI) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

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  • CMI

It is hard to get excited after looking at Cummins' (NYSE:CMI) recent performance, when its stock has declined 8.2% over the past three months. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Cummins' ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Cummins

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Cummins is:

25% = US$2.2b ÷ US$8.8b (Based on the trailing twelve months to July 2021).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.25 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of Cummins' Earnings Growth And 25% ROE

First thing first, we like that Cummins has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 11% also doesn't go unnoticed by us. This probably laid the groundwork for Cummins' moderate 11% net income growth seen over the past five years.

We then compared Cummins' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 8.1% in the same period.

past-earnings-growth
past-earnings-growth

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is CMI fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Cummins Using Its Retained Earnings Effectively?

Cummins has a three-year median payout ratio of 36%, which implies that it retains the remaining 64% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Additionally, Cummins has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 31% of its profits over the next three years. Accordingly, forecasts suggest that Cummins' future ROE will be 29% which is again, similar to the current ROE.

Conclusion

In total, we are pretty happy with Cummins' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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.

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