Are Robust Financials Driving The Recent Rally In Cummins India Limited's (NSE:CUMMINSIND) Stock?

Cummins India (NSE:CUMMINSIND) has had a great run on the share market with its stock up by a significant 43% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Cummins India's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Cummins India

How Do You 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 India is:

25% = ₹15b ÷ ₹61b (Based on the trailing twelve months to December 2023).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.25 in profit.

What Has ROE Got To Do With 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 India's Earnings Growth And 25% ROE

To begin with, Cummins India seems to have a respectable ROE. Especially when compared to the industry average of 17% the company's ROE looks pretty impressive. This probably laid the ground for Cummins India's moderate 19% net income growth seen over the past five years.

We then performed a comparison between Cummins India's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 22% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Cummins India's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Cummins India Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 56% (or a retention ratio of 44%) for Cummins India suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Moreover, Cummins India 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 46%. Accordingly, forecasts suggest that Cummins India's future ROE will be 26% which is again, similar to the current ROE.

Conclusion

Overall, we are quite pleased with Cummins India's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.