Yahoo Finance Cummins Inc. (NYSE:CMI) Stock's Been Sliding But Fundamentals Look Decent: Will The Market Correct The Share Price In The Future?
It is hard to get excited after looking at Cummins' (NYSE:CMI) recent performance, when its stock has declined 6.6% over the past month. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Cummins' ROE today.
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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
Check out our latest analysis for Cummins
How Is ROE Calculated?
Return on equity 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:
20% = US$2.1b ÷ US$10b (Based on the trailing twelve months to March 2024).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.20.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Cummins' Earnings Growth And 20% ROE
To begin with, Cummins seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 14%. For this reason, Cummins' five year net income decline of 2.8% raises the question as to why the high ROE didn't translate into earnings growth. Therefore, there might be some other aspects that could explain this. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.
So, as a next step, we compared Cummins' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 8.9% over the last few years.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. 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?
In spite of a normal three-year median payout ratio of 40% (that is, a retention ratio of 60%), the fact that Cummins' earnings have shrunk is quite puzzling. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
Moreover, Cummins has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 35% of its profits over the next three years. Regardless, the future ROE for Cummins is predicted to rise to 25% despite there being not much change expected in its payout ratio.
Conclusion
Overall, we feel that Cummins certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings 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.
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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.
