Is Cummins Inc. (CMI) Destined for Greatness?

Every investor can appreciate a stock that consistently beats the Street without getting ahead of its fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with improving financial metrics that support strong price growth. Let’s take a look at what Cummins Inc. (NYSE:CMI)‘ recent results tell us about its potential for future gains.

What the numbers tell you
The graphs you’re about to see tell Cummins Inc. (NYSE:CMI)’ story, and we’ll be grading the quality of that story in several ways.

Growth is important on both top and bottom lines, and an improving profit margin is a great sign that a company’s become more efficient over time. Since profits may not always reported at a steady rate, we’ll also look at how much Cummins Inc. (NYSE:CMI)’ free cash flow has grown in comparison to its net income.

A company that generates more earnings per share over time, regardless of the number of shares outstanding, is heading in the right direction. If Cummins Inc. (NYSE:CMI)’ share price has kept pace with its earnings growth, that’s another good sign that its stock can move higher.

Is Cummins Inc. (NYSE:CMI) managing its resources well? A company’s return on equity should be improving, and its debt-to-equity ratio declining, if it’s to earn our approval.

Healthy dividends are always welcome, so we’ll also make sure that Cummins Inc. (NYSE:CMI)’ dividend payouts are increasing, but at a level that can be sustained by its free cash flow.

By the numbers
Now, let’s look at Cummins’ key statistics.

CMI Total Return Price data by YCharts.

Passing Criteria	3-Year* Change	Grade
Revenue growth > 30%	60.5%	Pass
Improving profit margin	8.3%	Pass
Free cash flow growth > Net income growth	1.9% vs. 284.3%	Fail
Improving EPS	301.4%	Pass
Stock growth (+ 15%) < EPS growth	163.8% vs. 301.4%	Pass

Source: YCharts.
*Period begins at end of Q4 2009.

CMI Return on Equity data by YCharts.

Passing Criteria	3-Year* Change	Grade
Improving return on equity	117.2%	Pass
Declining debt to equity	(33.8%)	Pass
Dividend growth > 25%	185.7%	Pass
Free cash flow payout ratio < 50%	39.9%	Pass

Source: YCharts.
*Period begins at end of Q4 2009.

How we got here and where we’re going
Cummins sure looks to be justifying its recent placement atop The Motley Fool’s list of America’s Best Companies — at least from an investor standpoint. The engine maker misses out on a perfect score only because its net income has grown faster than its free cash flow. This isn’t cause for concern, as Cummins’ free cash flow has been higher than its net income for all of our tracking period, and even today it remains more than twice as high as reported net income. Any growth in the future would be icing on the cake. But what will it take for Cummins to earn a very rare perfect score?