Yahoo Finance A Close Look At Cummins Inc.’s (NYSE:CMI) 21% ROCE
Today we are going to look at Cummins Inc. (NYSE:CMI) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.
First of all, we'll work out how to calculate ROCE. Second, we'll look at its ROCE compared to similar companies. Last but not least, we'll look at what impact its current liabilities have on its ROCE.
What is Return On Capital Employed (ROCE)?
ROCE measures the amount of pre-tax profits a company can generate from the capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.
So, How Do We Calculate ROCE?
Analysts use this formula to calculate return on capital employed:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
Or for Cummins:
0.21 = US$2.8b ÷ (US$20b - US$6.7b) (Based on the trailing twelve months to September 2019.)
Therefore, Cummins has an ROCE of 21%.
View our latest analysis for Cummins
Is Cummins's ROCE Good?
When making comparisons between similar businesses, investors may find ROCE useful. Using our data, we find that Cummins's ROCE is meaningfully better than the 11% average in the Machinery industry. We consider this a positive sign, because it suggests it uses capital more efficiently than similar companies. Regardless of the industry comparison, in absolute terms, Cummins's ROCE currently appears to be excellent.
You can click on the image below to see (in greater detail) how Cummins's past growth compares to other companies.
Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. Since the future is so important for investors, you should check out our free report on analyst forecasts for Cummins.
Do Cummins's Current Liabilities Skew Its ROCE?
Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. Due to the way ROCE is calculated, a high level of current liabilities makes a company look as though it has less capital employed, and thus can (sometimes unfairly) boost the ROCE. To counteract this, we check if a company has high current liabilities, relative to its total assets.
Cummins has total assets of US$20b and current liabilities of US$6.7b. Therefore its current liabilities are equivalent to approximately 33% of its total assets. Cummins has a medium level of current liabilities, boosting its ROCE somewhat.
What We Can Learn From Cummins's ROCE
Despite this, it reports a high ROCE, and may be worth investigating further. There might be better investments than Cummins out there, but you will have to work hard to find them . These promising businesses with rapidly growing earnings might be right up your alley.
I will like Cummins better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.
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