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An Analysis Determining If Cummins Inc. Should Motor Its Way Into My Portfolio

Cummins Inc. has seen a 38% downturn in its stock in the last year and a half, prompting me to take a closer look at the company.

I analyze if this downturn is an opportunity to add Cummins to my portfolio or a warning to stay away.

The company is very shareholder-friendly as revenue, net income, payout ratio, and financial discipline has been solid over the long term.

After monitoring the recent downturn as well as determining its fair value, I believe the company's stock is ready to be purchased.

As my readers know I cover a fair amount of stocks that are considered growth stocks. I follow - but cover more slowly - stocks that are considered dividend growth stocks also. This approach allows me to keep a balanced and diversified portfolio and, in accordance with my young investor's portfolio, move profits from growth stocks to dividend stocks.

In keeping with that approach I keep a list of stocks that I continually monitor. Then, when I see a dramatic drawn-out price decline in any of them, I dig deeper into that stock's situation. This digging deeper either leads to my action of investing in the stock in question or leads me to the conclusion that there is more downside to be had and thus more time to wait. The reason why the decision is one or the other is due to having done the homework on the stock over the course of the months - and sometimes years - prior to seeing the price decline. Therefore, it is just a matter of checking the facts again before determining if I will put a buy order in. Otherwise, if something substantial changes in the investment theory a stock won't make it this far and will be removed from my monitored list of stocks.


With that said, the most recent stock to drop into my decision bucket is Cummins Inc. (NYSE:CMI). I have been following Cummins for the last year and a half. Initially drawn in by its cash-generating business model, as well as its engine and power business in general, I began to see how improved the company had been over the last several years. For example, the company has increased earnings by 125% as well as grown the dividend by 680% since 2007. But, these are just some of the initial reasons why I've kept my eye on the company. In this article I will go over more reasons as well as discuss why now might be the time to add CMI to my portfolio.

Company Background

Cummins Inc. is known for designing and selling diesel and natural gas engines. Many of us see them in Dodge Ram pick-up trucks in the form of the 6.7L inline six engine. And, coming shortly Cummins will also provide a 5.0L V8 engine for the 2016 Nissan Titan. Where many people don't see them but is in fact a large percentage of their business is in fleet and heavy duty trucks. Some of their customers include International Truck (NAV) and Volvo Trucks North America. The company produces engines in the form of their ISM, ISX, ISB, ISC, and ISL series, in which some are used in long-term contracts with Volvo and International. This division makes up about 42% of the company's sales.

The company also has divisions in power generation, distribution, and filtration and other business. These divisions contain generators, transfer switches, intake and exhaust systems, turbochargers, filters, and retail distribution networks. These divisions collectively make up about 58% of sales.

Why I'm Prompted To Take A Closer Look

Since June of last year the company's stock price has been in a steady decline. Last year the stock was nearing all-time highs in the high 150s while today it sits in the high 90s, a near 38% decrease. This drawn out decrease in stock price has alerted me to a potential long-term investment opportunity in the company. However, examination needs to be done to determine if this beating down in stock price is an opportunity or a warning sign.

Understanding The Company's Financials

Revenue from the company has increased in a somewhat predictable trend over the course of the last three decades even in the face of the cyclical market it caters to as well as the broader market. The following chart shows this 30-year period and the revenue generation of the company.

As we can see the company has continually increased revenue over the long term and recovers relatively quickly in the aftermath of an economic or industrial market downturn. Over the last 10 years the company has grown revenue at a rate of 6.5% per year.

In noticing this I also decided to look at the share price of the company in comparison to revenue growth. What I found in regards to this past year-or-so's downtrend is there is quite a divergence in the two that had not been seen before.

In all other time periods there was a general in-step association between revenue and stock price. Today we are seeing the beginning of what is expected to be a small decrease in revenue over the next year but a serious drop in stock price. Even if this price drop is an anticipation of further revenue...