Over the past six months, Cummins has been a great trade, beating the S&P 500 by 16.4%. Its stock price has climbed to $364.40, representing a healthy 21.7% increase. This was partly due to its solid quarterly results, and the performance may have investors wondering how to approach the situation.
Is now the time to buy Cummins, or should you be careful about including it in your portfolio? See what our analysts have to say in our full research report, it’s free.
We’re happy investors have made money, but we're sitting this one out for now. Here are three reasons why you should be careful with CMI and a stock we'd rather own.
Why Is Cummins Not Exciting?
With more than half of the heavy-duty truck market using its engines at one point, Cummins (NYSE:CMI) offers engines and power systems.
1. Long-Term Revenue Growth Disappoints
A company’s long-term sales performance can indicate its overall quality. Any business can put up a good quarter or two, but many enduring ones grow for years. Unfortunately, Cummins’s 7.2% annualized revenue growth over the last five years was mediocre. This was below our standard for the industrials sector. 
2. Free Cash Flow Margin Dropping
Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
As you can see below, Cummins’s margin dropped by 8.3 percentage points over the last five years. This along with its unexciting margin put the company in a tough spot, and shareholders are likely hoping it can reverse course. If the trend continues, it could signal it’s becoming a more capital-intensive business. Cummins’s free cash flow margin for the trailing 12 months was breakeven.
3. New Investments Fail to Bear Fruit as ROIC Declines
ROIC, or return on invested capital, is a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).
We typically prefer to invest in companies with high returns because it means they have viable business models, but the trend in a company’s ROIC is often what surprises the market and moves the stock price. Cummins’s ROIC has decreased over the last few years. We like what management has done in the past, but its declining returns are perhaps a symptom of fewer profitable growth opportunities.
Final Judgment
Cummins isn’t a terrible business, but it doesn’t pass our quality test. With its shares beating the market recently, the stock trades at 16× forward price-to-earnings (or $364.40 per share). This valuation tells us it’s a bit of a market darling with a lot of good news priced in - we think there are better opportunities elsewhere. We’d suggest looking at KLA Corporation, a picks and shovels play for semiconductor manufacturing.
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