With a price-to-earnings (or "P/E") ratio of 11.6x Cummins Inc. (NYSE:CMI) may be sending bullish signals at the moment, given that almost half of all companies in the United States have P/E ratios greater than 17x and even P/E's higher than 32x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the reduced P/E.

With its earnings growth in positive territory compared to the declining earnings of most other companies, Cummins has been doing quite well of late. One possibility is that the P/E is low because investors think the company's earnings are going to fall away like everyone else's soon. If not, then existing shareholders have reason to be quite optimistic about the future direction of the share price.

View our latest analysis for Cummins

What Are Growth Metrics Telling Us About The Low P/E?

In order to justify its P/E ratio, Cummins would need to produce sluggish growth that's trailing the market.

Retrospectively, the last year delivered an exceptional 46% gain to the company's bottom line. The strong recent performance means it was also able to grow EPS by 85% in total over the last three years. So we can start by confirming that the company has done a great job of growing earnings over that time.

Shifting to the future, estimates from the analysts covering the company suggest earnings should grow by 2.7% per year over the next three years. That's shaping up to be materially lower than the 13% per year growth forecast for the broader market.

With this information, we can see why Cummins is trading at a P/E lower than the market. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.

The Key Takeaway

It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.

We've established that Cummins maintains its low P/E on the weakness of its forecast growth being lower than the wider market, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. It's hard to see the share price rising strongly in the near future under these circumstances.

Don't forget that there may be other risks. For instance, we've identified 1 warning sign for Cummins that you should be aware of.

Of course, you might also be able to find a better stock than Cummins. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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