It is hard to get excited after looking at Cummins' (NYSE:CMI) recent performance, when its stock has declined 1.4% over the past week. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Cummins' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Cummins

How Is ROE Calculated?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Cummins is:

36% = US$4.1b ÷ US$11b (Based on the trailing twelve months to December 2024).

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 $0.36 in profit.

Why Is ROE Important For 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. 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 36% ROE

First thing first, we like that Cummins has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 15% which is quite remarkable. This probably laid the groundwork for Cummins' moderate 5.3% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Cummins' reported growth was lower than the industry growth of 15% over the last few years, which is not something we like to see.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. What is CMI worth today? The intrinsic value infographic in our free research report helps visualize whether CMI is currently mispriced by the market.

Is Cummins Efficiently Re-investing Its Profits?

Cummins has a healthy combination of a moderate three-year median payout ratio of 40% (or a retention ratio of 60%) 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 33% of its profits over the next three years. Still, forecasts suggest that Cummins' future ROE will drop to 25% even though the the company's payout ratio is not expected to change by much.

Conclusion

In total, we are pretty happy with Cummins' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a respectable growth in its earnings. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.