Cummins India (NSE:CUMMINSIND) Could Be Struggling To Allocate Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Cummins India (NSE:CUMMINSIND) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Cummins India, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.16 = ₹7.9b ÷ (₹60b - ₹11b) (Based on the trailing twelve months to June 2021).

Therefore, Cummins India has an ROCE of 16%. That's a relatively normal return on capital, and it's around the 14% generated by the Machinery industry.

Check out our latest analysis for Cummins India

In the above chart we have measured Cummins India's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

On the surface, the trend of ROCE at Cummins India doesn't inspire confidence. Around five years ago the returns on capital were 20%, but since then they've fallen to 16%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

The Bottom Line On Cummins India's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Cummins India is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 26% gain to shareholders who've held over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

One more thing, we've spotted 1 warning sign facing Cummins India that you might find interesting.

While Cummins India may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.
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