Cummins (CMI): Record Quarter, Falling Stock — What Wall Street Sees

0:00So Cummins just posted up a monster Q2. I mean, a record Q2 in revenue. Up 9 % from what they were projecting for Q2. North America was up. International was up. Everything is up. Their EBITDA looks healthy. And management even went as far as to raise their full year growth guidance. And that's exactly the kind of headline that sets a trap for us investors. We assume that just because they had a good quarter, that equals a good company, which equals a good stock. So today, Andrew and I are doing the exact opposite of that. We are assuming it's not a good company and it's not a good stock. And we're going to start breaking it down.

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2:45Your path to financial freedom. Start now. And welcome back to the Investing for Beginners podcast, everybody. My name is Stephen Morris and across from me is the Andrew Saylor. That's right. He is the Andrew Saylor, just like the Ohio State University. I feel like at this point, Andrew, you've earned the the in front of your name. How does that make you feel? Does that make you feel like the future national championship winner? Or are you going to be humble and be like, nah, I'm just the Andrew? There's a few. That's funny. Me and Evan had this exact conversation. There's a few Andrew say there's and so I'm honored that Stephen Morris thinks that I am the Andrew say it there, but I have not won a championship against other Andrew say there's to prove this for fact so let everybody else decide well i mean did ohio state well i guess yeah okay that's fair i guess they they have other schools in ohio that they that's fair okay fair statement but anyway i'm gonna i coined it anyway so the other andrew sailors can kick rocks um because i said so anyways so we're talking cummins today andrew and it got on my radar because like i said in the intro they posted a massive massive like nine point was it 9.2 9.5 billion dollars above projected for q2 and it's just insane man like absolutely insane growth but what really struck me when i looked at it is while they are posting these insane q2 numbers their stock price is just continuing to fall since June.

4:38So that got me curious. What is it about the business? Why are they posting such great numbers? And yet their stock price is falling. What does Wall Street see that I do not? So what did you come to? Well, or maybe first, sorry, before we jump the gun, like what steps did you take to try to answer that question? Because that's a question you see with lots of stocks, right? So the very first thing I did was I went and listened to their Q2 earnings goal. And I answered the main question right off the bat, which when you and I talked about it, it was how, how did this happen? And that has a lot to do with providing power, power trains for data centers, just like with CAT.

5:27So massive growth there. But it's not just their data center work either, Andrew. They're doing a lot of work in Destination Zero, which is their work towards battery power, clean energy type power as well. So, I mean, the future is looking bright, maybe, for Cummins. but again like that's just scratching the surface of what the company actually is so i was i will admit i was pretty surprised listening to their earnings call and hearing um just how many buckets they have they aren't just making dodge engines or you know farm equipment engines they're they're they're branching out into lots and lots of other things What about you?

6:21What would your first step be when trying to figure this out? Partly, this doesn't count in my normal process because I actually owned this stock before. I sold it in 2024 to buy Starbucks, which was added to my list of dumb mistakes. Starbucks did not do well. Cummins has done well. Story of my portfolio in some respects. But one of the things I like to do, and I guess it changes and it depends, and you can't apply this to every company, but I like to look at what's their segment revenue and what's their segment profitability. So some companies break this out. There's other companies that are pure play like Netflix.

7:13They just have their one segment. But other companies, especially a conglomerate, big, like you mentioned, a lot of pieces, a lot of stakes in the fire, will have segment reporting. And so if we look at, we can use fiscal AI. So you can use the 10K or you can use fiscal AI to do this. So I looked at fiscal AI. They have a segments tab. And so they have engines is one segment. They have components. They have distribution. They have power systems and they have Accelera. So one of the things that stood out to me when I was looking at this data, because I remember when I bought it, I always looked at it from the engine standpoint.

7:58Their engines go into the big tractor trailers, like the ones made by Packer and things like that. And so one of the reasons why I sold it is because I couldn't get over the idea that eventually these diesel engines on these big trucks could be replaced someday by autonomous, which could become electrified instead of diesel. So it was just another of those stocks where I did not feel like 20 years from now, I would feel happy about it. So that's kind of how I always looked at it. But then when I looked at where their profits have come from lately, to your point about the power stuff that they're doing and the data center build-outs, even though the revenue is much, much smaller, their profit levels from power systems has now become the biggest segment, certainly for the latest Q2 and then also over the last 12 months.

8:57So that becomes really, really interesting where you have this company that's kind of, they're not pivoting per se, but they just have this piece of the business that's just expanding so much faster than the rest of their legacy business. And it reminds me of like Amazon, Microsoft, and Alphabet, where they have their legacy businesses that everybody knows. But then there's these really fast growing pieces of their business that are tied to AI and cloud computing. so it's a really fascinating company and it's fun to look I don't know maybe it's just me I'm weird but it's fun to look at stocks that are going through transformations because then the romantic side of my brain gets really excited of like okay maybe Wall Street is not discounting this part of the growth story potentially so you get this idea like oh maybe I can be there first and then you also get kind of the upside of like well they have a legacy business so there's some stability in cash flows and profitability that they could use to reinvest in something like this and become a key leader.

10:06So a lot of thoughts, but I really like to look past the headlines to answer your question. I like to look past the headlines. I like to look at what are the actual numbers behind different segments and then try to make observations about how those things are progressing. So we could talk about power. The other interesting thing too is they have the distribution business and components business, which ties into their engines business and those kind of work like a flywheel too. So it's definitely an interesting business to look at in both of those ways. And like I said, it's super interesting. So when we were talking about it and I asked the question, why are they falling like a rock if they're posting such outrageous numbers?

11:00And your first comment, I don't know if you remember, but your very first comment was, well, that probably has something to do with data centers and Wall Street is being pretty bearish on AI right now. and that's driving their numbers down. So, Andrew, if I'm looking at this, how can I discern if that is the case? What should my steps be to go through the 10K or fiscal and figure out that is actually the case? Yeah, I mean, how do we figure out where the popular crowd's going and what they're going to like next and why they're behaving like they're behaving. It's such a hard thing. It's one of those examples where looking at things that we usually like to just dog on, like analyst reports, things like that, that can give some light into why stock prices are moving.

12:08So to go back to fiscal AI, they have a bull say and a bear say segment. in the company overview. And so in the Bears say, which is basically it's just AI. It's taking different research reports that they can find online and summarizing some of that. In this case, they're summarizing Morningstar. And they're saying that there's trade wars and supply chain disruptions, which could reduce freight demand. Environmental regulations could prove onerous and the market may be disrupted by innovation in alternative propulsion like Tesla and Rivian. And that was as of August 31st. So I don't know. I mean, those all make sense.

12:50And actually, if you listen to the call, the most recent call, it is interesting to hear that they are talking about pressures to margins, things like tariffs and supply chain and things like that. So I don't know. My initial guess sounded really good to me, and I was like, I'm correct. Totally. How could I ever be wrong? but there seems to be other things going on as well which it's hard to say how much is this and how much is that but that's kind of the nature of Wall Street was there anything else that kind of stood out to you in the call or did you find a different conclusion as to why the price has been beaten down just to give context real quick it had gotten up to over 700 the share it's now around 500 so and that was in June right uh, June of this year, it got up to 700.

13:44Yeah. So, I mean, that's a pretty steep drop in just two months. Um, yeah, Andrew, kind of the conclusion I came to had absolutely nothing to do with wall street and rather, um, the, their, their, their costs are going through the roof. Like you said, tariffs are a huge thing. Um, but it's not just tariffs. Inflation is hitting them hard as well. Uh, because they don't make everything they need in-house like cat does um their their contractors things like that prices are going up which is forcing them even though they had such you know uh you know they had the record 9.46 billion uh it's it's getting chipped away pretty steadily due to the rising costs.

14:37And then you have, you know, all of that at the end of the day starts squeezing in on their margins, which I guess kind of makes sense that it would make Wall Street kind of be a little bit more bearish towards them. But I mean, still, I don't know. maybe it's just my logical brain doesn't think like wall street you know if you're posting a record q2 of 9.46 billion like it's like that's you can't sneeze at that like that that's still a record profit and it makes me ask the question then what what does good look like you know so So yes, their costs are rising rapidly, which they do talk about.

15:32Their costs are rising rapidly, but their revenue is also rising rapidly. So what does good look like? You know what I mean? Is it like zero costs and then we're making a trillion dollars? Is that good or is Wall Street going to find a reason to be bearish on that too? Yeah, it's a very good question. And so this is where some of the things that we like to talk about that people start to snooze when we talk about starts to come into play. And that's profit margins. So you want to look at gross profit margin and operating margin. And so if we see those numbers trending down, that's a sign that costs are increasing faster than revenues.

16:15If those percentages are going up, that's a sign that even though costs are higher, they're able to pass on those costs. So in the case of Cummins, I'm just looking at quarterly numbers. Gross margin has been pretty flat over the last, call it, 8-12 quarters, maybe a tad higher. And operating margin is starting to rebound. But if we look at a longer term trend, I noticed that operating margin is not as high as it used to be, call it 10 years ago, but it's still stayed flat since 2017. so part of me thinks it's not a margin story per se but here's another thing that we have to think about and where what you're talking about of being aware of how the business is structured, are they vertically integrated are they depending on suppliers, what are the relationships with the suppliers Wall Street isn't looking at what happened last quarter or the next quarter.

17:28Wall Street's looking at what's going to happen over the next four quarters, eight quarters, 12 quarters. And so that's where if we have special insight into what the business does and where their competitive advantages are, we can get a better sense of maybe this is why stock price is moving like it is. I'm not going to lie. Running a small business has been stressful lately, swamped in paperwork, different state agencies, and got all these expenses to track and everything. And it's hard to have visibility on these things. But I've stumbled on a better solution, kind of like a one-stop shop for my bookkeeping, my expenses, my P &L, my banking, my contractor payments, all of the messy pieces.

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19:36Offer valid September 24th, 2026 through October 4th, 2026. Exclusions apply. For licenses, see homedepot.com slash license numbers. What's the best way to get started in the market? download my ebook for free at stockmarketpdf.com. And I love that you say that because you have no ability to see my show prep. And that leads us perfectly into the next part of my show prep, which is their moat. And I think Cummins, without exaggeration, is probably one of the most well-known brands when it comes to what they do i mean they're they're basically the nike of engines um because when i heard i don't i think i was driving when i heard the report about um the the the nine percent increase and i was like holy crap and my wife was wherever I was, my wife was close to me.

20:40And I was like, holy crap. And she's like, what? I'm like, Cummins apparently is killing it. And she goes, they make engines, right? So, I mean, if my wife knows who Cummins is, then I think it's safe to say most of the United States, if not most of the world, knows who Cummins is. So, I mean, definitely, I think it's safe to say they're the nike of of engines slash power trains um which means reasonable to say going into this research that they have a fairly decent moat uh built around them they have the brand identity they're the right how do you say that reckon recognize i don't even know people recognize them that's how i'm going to say that but is there anything else you noticed specifically about Cummins and Moe when you bought them initially or in preparing for for this episode that really stood out to you that made you make like that's that's solid yeah kind of like you're saying the the size difference between them and the competition.

22:00I remember how they had different JV partnerships. And I was surprised when we were diving back into this company. They actually are kind of like a China play. They have these joint ventures in China and that kind of plays into their growth story as well.

22:22But I guess one of the things that is interesting is I think it was Packers 10K, but they have to mention who their biggest suppliers were and Cummins was on there. So it's your point about just having that presence as a supplier to people who are buying engines. Cummins has a definite lead. That's all I have. Definitely. and I would say for me it's the demand for quality they talk about it in their earnings they talk about it in their 10k it's all over their website they care about the quality of what they manufacture and even when they're talking about destination zero one of the biggest hurdles that they talk about is having having to overcome is get these green power trains whether it's battery or whatever um up to the cummins quality standard and i think that to me that's like one of the one of the biggest selling points now let me be perfectly clear i am a customer service quality nut i will pay extra for good customer service i will i will do whatever is necessary for quality um people ask me why uh i use usaa for insurance rather than someone else who's way way cheaper because usa their car insurance is pretty expensive um but their their customer support man like you can't beat it like they have the best customer service anyone i've ever talked to and so to me like that instantly is a huge green flag for me i guess is knowing that they take their their their quality and their customer support very very seriously uh from the top all the way down and so and they talk about you know the the measures they put into place to ensure that they are providing good engines and power trains and everything in between their products are always solid dependable and live up to the cummins name and hashtag they are literally like an hour and a half from me here in indiana so i mean that's just like that's a bonus like extra thousand points that is the longest hashtag i've ever heard of

25:06fair I feel like that summarizes it really well and it's interesting that they're talking about the Zero the whole push to invest in Zero I'd be curious how well that does I mean obviously it's a story we'll see how it plays out how well that helps them fight against the risk of the alternatives for engines that have been coming and being developed and things like that. I mean, a while back, I want to say five years ago, my dad was telling me about a piece of equipment that they had gotten from John Deere to test. And I don't remember what it was, whether it was like a front-end loader or a big truck or a haul truck, but it was a giant piece of mining equipment.

26:01And it was John Deere in partnership with Cummins and it was completely 100 % green, no emissions. And they gave it to the mine my dad was at to just run it through the ring or put it through some real-life testing and see what happened. My dad absolutely hated it with a passion. But, I mean, again, that just shows me, even though my dad didn't like it that model of it like that was probably 10 15 million dollar piece of equipment if not more um that they they just handed over to to a mining company and said here go go run this like you do day to day and tell us what happens um to me that that just showed i mean some people might see it as wasting money i see it as just outstanding quality assurance.

27:05I think my next, I guess, biggest concern, Andrew, with Cummins is how cyclical of a company is it? Is that something that we should be concerned with when it comes to engines, powertrains, things like that? Or is it just where we know that Cummins is going to be producing no matter what? That's a fantastic question. How would we find out the answer to that question going through like their 10K and reports and stuff like that? Yeah. So fantastic question. It's going to determine where our ending valuation lands because if something's more cyclical, then we don't want to overpay for boom time earnings.

27:58And so it's a question I try to ask for every company. One way you can do this is by looking at their operating margin over time. And so I used ROIC.ai for this because they offer it for free. You can go back basically since the company IPO'd. But if I look back at their operating margin trend line, they do have some cyclicality where during tough time periods, operating margin did come down. So I'm talking about 2009, there was a pretty big dip. Operating margins fell by more than half. And then similarly in 2022-23, when we had that mini recession, really took stocks down with it. They also saw margins come down by more than half.

28:51But that's only a one-year, in the case of 2009, 2008, like a one - to two-year timeframe, and then all the rest of it is pretty steady from the margin perspective. And so if I were to revalue this company again, I would probably say it's average cyclicality or maybe slightly above average cyclicality, just strictly from looking at the margins. You can also look at revenue growth over time. That's another good way to see if there's big jumps. But if I compare this to the extreme, like a home builder, I put Pulte through this test and you could see for like four years, just negative earnings. Definitely not as cyclical as a home builder.

29:37So you can call it a cyclical with maybe a little bit of added cyclicality, but I wouldn't consider it a super cyclical, like a home builder within that spectrum. I love that. And when you talk about those years, I mean, 2008, 2009, pretty big market shift those years. We talk about 2022, 2023, that's COVID, recovering from COVID. So yeah, it makes sense that those years would affect them because it's affecting their customers. So, I mean, I feel like that's something I could even look at and kind of disregard because it's, you know, yeah, it makes total sense that they were affected during that time.

30:36And I don't know, is that a wrong way to look at it? like, eh, whatever. Like 2008, 2009 was hard for everybody. So I mean, or is that something I should still take into account as if it was, you know, 2016 when the market's booming and they have that same dip? Does that make sense? It does. Yeah. I mean, I like to answer with numbers. So to me, it's like the answers we've already solved. But we can also think about their business as a whole. So yes, part of it, they do, like CAT, sell to the construction industry. They do sell their diesel engines to the big tractor trailers. So that's logistics industry.

31:26While those might have cyclicality, those cycles might not line up perfectly. So in a way, the fact that they're more diversified in their end markets could make it less bumpy than being all in one end market, all tied to something as cyclical as housing. Love it. So without getting crazy into earnings statements and everything, is there anything that really stood out to you when you looked at them this time? Not previous when you invested, but this time, Is there anything that stood out that might send up red flags in their earnings statements? Thinking about refreshing the carpet in your home?

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32:51So when the plates are empty and the sink is full, use Palmolive Ultra. Palmolive's most powerful formula removes up to 99.9 % of grease, leaving your dishes sparkling clean. And the new convenient pump makes cleaning even easier, so you can spend less time tackling dishes and more time together. Shop now at palmolive.com. So not like a red flag, maybe a yellow flag. ROAC is kind of slowly sloping downwards. Very long-term trend, just slowly sloping downwards. And so I wonder why is that the case? from a growth perspective with everything that you just mentioned with the earnings where they're guiding to where things look like they're going in the future, growth is looking like it's going to come back and become strong again.

33:42And maybe that affects ROIC. But for whatever reason, when I see a chart like that that's just slowly sloping down for ROIC, like a little kind of mini staircase, I just get mature company vibes. And so I would want to have a compelling thesis to why this is not a mature company and why this is a kind of middle stage, healthy growth at a value price kind of company. so andrew say we have a brand new investor listening to us right now and um first of all welcome welcome to the crazy the crazy circle um but uh say say they're they're brand new and they hear this amazing earning a quarter earnings statement and they're like wow that's crazy are there a couple of ways you can think of off the top of your head that might show them whether or not this is a strong company or if it's kind of like a fake strong?

34:46Yeah, great question. Something that definitely looking past the headline numbers. So one thing, any company can juice a short-term quarter results by doing the big acquisition, big splashy acquisition, spend a bunch of money, buy another company. So that can boost your profits as that gets integrated. and we should understand that you can't, unless you are somebody who can just, I don't know, you're like a Broadcom. Broadcom is like the exception because they've been able to just acquire like crazy. But outside of that, you shouldn't expect these big jumps from revenue from acquisitions to be able to continue.

35:29And so you look at that, okay, it's probably one time in nature. And then on the flip side, the profits growing really, really quickly. There are one-time events that can affect these things. I was just looking at a company, Florinda Core. They mentioned that they had a tariff hit a few years ago, and then they actually got credited back, kind of like a tariff refund. And so if you weren't paying attention to that, you might have saw record profit, record earnings, and then kind of, you know, your model just gets screwed up there. So you look for the big acquisition, you look for one-time effects.

36:13It could be taxes, it could be tariffs, it could be expenses, whatever it is. Adjust for those and don't expect that those kinds of big boosts are going to continue indefinitely. Otherwise, you're going to find yourself being really excited for a company that's actually not in the middle of a transformation. Yeah, I love it. I mean, and that's so hard to pick out too sometimes because companies are really good at hiding stuff like that sometimes. Yeah. Especially on like the tariff refund. Like, I don't even worry, where would you even look for that? I don't think I've ever seen something like that in a 10K before.