Cummins Inc.'s (NYSE:CMI) Stock Is Going Strong: Is the Market Following Fundamentals?

Cummins (NYSE:CMI) has had a great run on the share market with its stock up by a significant 16% over the last three months. 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. Particularly, we will be paying attention to Cummins' ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Cummins

How To 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$1.7b ÷ US$8.1b (Based on the trailing twelve months to June 2020).

The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.21.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Cummins' Earnings Growth And 21% ROE

To begin with, Cummins seems to have a respectable ROE. Especially when compared to the industry average of 10% the company's ROE looks pretty impressive. Probably as a result of this, Cummins was able to see a decent growth of 11% over the last five years.

We then performed a comparison between Cummins' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 10% in the same 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. This then helps them determine if the stock is placed for a bright or bleak future. 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 healthy combination of a moderate three-year median payout ratio of 42% (or a retention ratio of 58%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 39%. However, Cummins' ROE is predicted to rise to 30% despite there being no anticipated change in its payout ratio.

Summary

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. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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. 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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