Cummins India (NSE: CUMMINSIND) may struggle to allocate capital

If you are looking for a multi-bagger, there are a few things to look out for. Among other things, we’ll want to see two things; first, a growth to recover on capital employed (ROCE) and on the other hand, an expansion of the amount capital employed. Basically, it means that a business has profitable initiatives that it can keep reinvesting in, which is a hallmark of a dialing machine. However, after briefly reviewing the numbers, we don’t think Cummins India (NSE: CUMMINSIND) has the makings of a multi-bagger in the future, but let’s see why this may be the case.

What is Return on Employee Capital (ROCE)?

If you’ve never worked with ROCE before, it measures the “return” (profit before tax) that a business generates on capital employed in its business. To calculate this metric for Cummins India, here is the formula:

Return on capital employed = Profit before interest and taxes (EBIT) ÷ (Total assets – Current liabilities)

0.16 = ₹ 7.9b ÷ (₹ 60b – ₹ 11b) (Based on the last twelve months up to June 2021).

Therefore, Cummins India has a ROCE of 16%. This is a relatively normal return on capital, and it is around the 14% generated by the machinery industry.

Check out our latest review for Cummins India

In the graph above, we measured Cummins India’s past ROCE against its past performance, but the future is arguably more important. If you are interested, you can view analyst forecasts in our free analyst forecast report for the company.

How are the returns evolving?

On the surface, the ROCE trend at Cummins India does not inspire confidence. About five years ago, returns on capital were 20%, but since then they have fallen to 16%. Although, as income and the amount of assets used in the business have increased, this could suggest that the business is investing in growth and that the additional capital has resulted in a short-term reduction in ROCE. If these investments prove to be successful, it can bode very well for stock performance in the long run.

Cummins India ROCE result

In summary, despite lower returns in the short term, we are encouraged to see that Cummins India is reinvesting for growth and therefore has higher sales. These trends are starting to be recognized by investors as the stock has provided a 26% gain to shareholders who have held it over the past five years. Thus, this stock can still be an attractive investment opportunity, if other fundamentals prove to be solid.

One more thing, we spotted 1 warning sign facing Cummins India that you might find interesting.

While Cummins India does not currently generate the highest returns, we have compiled a list of companies that currently generate over 25% return on equity. Check it out free list here.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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