Cummins Inc.'s (NYSE:CMI) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

It is hard to get excited after looking at Cummins' (NYSE:CMI) recent performance, when its stock has declined 8.7% over the past month. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. 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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out 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:

21% = US$2.2b ÷ US$10b (Based on the trailing twelve months to December 2022).

The 'return' is the amount earned after tax over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.21 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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

To start with, Cummins' ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 13%. This certainly adds some context to Cummins' decent 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 7.4% 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. Has the market priced in the future outlook for CMI? You can find out in our latest intrinsic value infographic research report.

Is Cummins Efficiently Re-investing Its Profits?

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.

Besides, Cummins has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. 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%. Still, forecasts suggest that Cummins' future ROE will rise to 27% even though the the company's payout ratio is not expected to change by much.

Summary

Overall, we are quite pleased 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. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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.

What are the risks and opportunities for Cummins?

NYSE:CMI

Cummins

Cummins Inc. designs, manufactures, distributes, and services diesel and natural gas engines, electric and hybrid powertrains, and related components worldwide.Show more

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Rewards

• Trading at 6.8% below our estimate of its fair value

• Earnings are forecast to grow 6.2% per year

• Earnings have grown 7.3% per year over the past 5 years

Risks

• Significant insider selling over the past 3 months

• Has a high level of debt

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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.