Cummins Inc. definitely passes the initial requirements of both the Defensive Investor and the Enterprising Investor. The Defensive Investor’s only concern is the high PB ratio, while the Enterprising Investor has no initial concerns. This indicates the company presents a low risk level as its fundamentals are very strong. All value investors should feel very comfortable proceeding to the next part of the analysis, which is a determination of the company’s intrinsic value.
When it comes to that valuation, it is critical to consider the company’s earnings history. In this case, the company has grown its EPSmg (normalized earnings) from $3.83 in 2010 to an estimated $8.39 for 2014. This is a very strong level of demonstrated growth which is well above the market’s implied estimate for earnings growth of 4.43% over the next 7-10 years. In fact, the historical growth is around 23.75% per year, so the market is expecting a very significant drop in earnings growth. The ModernGraham valuation model reduces the historical growth to a more conservative figure, assuming that some slowdown will occur, and therefore returns an estimate of intrinsic value falling above the current price, indicating the company is undervalued at the present time.