There May Be Reason For Hope In Cummins' (NYSE:CMI) Disappointing Earnings

Cummins Inc.'s (NYSE:CMI) stock was strong despite it releasing a soft earnings report last week. However, we think the company is showing some signs that things are more promising than they seem.

Check out our latest analysis for Cummins

A Closer Look At Cummins' Earnings

As finance nerds would already know, the accrual ratio from cashflow is a key measure for assessing how well a company's free cash flow (FCF) matches its profit. To get the accrual ratio we first subtract FCF from profit for a period, and then divide that number by the average operating assets for the period. You could think of the accrual ratio from cashflow as the 'non-FCF profit ratio'.

That means a negative accrual ratio is a good thing, because it shows that the company is bringing in more free cash flow than its profit would suggest. While having an accrual ratio above zero is of little concern, we do think it's worth noting when a company has a relatively high accrual ratio. To quote a 2014 paper by Lewellen and Resutek, "firms with higher accruals tend to be less profitable in the future".

Over the twelve months to December 2023, Cummins recorded an accrual ratio of -0.14. That indicates that its free cash flow was a fair bit more than its statutory profit. To wit, it produced free cash flow of US$2.8b during the period, dwarfing its reported profit of US$735.0m. Cummins shareholders are no doubt pleased that free cash flow improved over the last twelve months.

That might leave you wondering what analysts are forecasting in terms of future profitability. Luckily, you can click here to see an interactive graph depicting future profitability, based on their estimates.

Our Take On Cummins' Profit Performance

Cummins' accrual ratio is solid, and indicates strong free cash flow, as we discussed, above. Based on this observation, we consider it likely that Cummins' statutory profit actually understates its earnings potential! Unfortunately, though, its earnings per share actually fell back over the last year. Of course, we've only just scratched the surface when it comes to analysing its earnings; one could also consider margins, forecast growth, and return on investment, among other factors. In light of this, if you'd like to do more analysis on the company, it's vital to be informed of the risks involved. For example - Cummins has 2 warning signs we think you should be aware of.

Today we've zoomed in on a single data point to better understand the nature of Cummins' profit. But there are plenty of other ways to inform your opinion of a company. Some people consider a high return on equity to be a good sign of a quality business. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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.