Is Cummins Inc.'s (NYSE:CMI) Stock's Recent Performance Being Led By Its Attractive Financial Prospects?
Cummins (NYSE:CMI) has had a great run on the share market with its stock up by a significant 5.7% over the last week. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Specifically, we decided to study Cummins' ROE in this article.
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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for Cummins
How Do You Calculate Return On Equity?
ROE can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Cummins is:
21% = US$2.2b ÷ US$10b (Based on the trailing twelve months to December 2022).
The 'return' is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.21 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
Cummins' Earnings Growth And 21% ROE
At first glance, Cummins seems to have a decent ROE. On comparing with the average industry ROE of 13% the company's ROE looks pretty remarkable. This probably laid the ground for Cummins' moderate 7.3% net income growth seen over the past five years.
As a next step, we compared Cummins' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 7.5% in the same period.
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). This then helps them determine if the stock is placed for a bright or bleak future. What is CMI worth today? The intrinsic value infographic in our free research report helps visualize whether CMI is currently mispriced by the market.
Is Cummins Using Its Retained Earnings Effectively?
With a three-year median payout ratio of 40% (implying that the company retains 60% of its profits), it seems that Cummins is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.
Moreover, Cummins is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 34%. Regardless, the future ROE for Cummins is predicted to rise to 27% despite there being not much change expected in its payout ratio.
Summary
Overall, we are quite pleased with Cummins' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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