With a price-to-earnings (or "P/E") ratio of 21.2x Cummins Inc. (NYSE:CMI) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 18x and even P/E's lower than 10x are not unusual. However, the P/E might be high for a reason and it requires further investigation to determine if it's justified.

With earnings that are retreating more than the market's of late, Cummins has been very sluggish. One possibility is that the P/E is high because investors think the company will turn things around completely and accelerate past most others in the market. If not, then existing shareholders may be very nervous about the viability of the share price.

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

There's an inherent assumption that a company should outperform the market for P/E ratios like Cummins' to be considered reasonable.

If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 23%. The last three years don't look nice either as the company has shrunk EPS by 5.4% in aggregate. Accordingly, shareholders would have felt downbeat about the medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 19% per annum during the coming three years according to the analysts following the company. That's shaping up to be materially higher than the 10% per annum growth forecast for the broader market.

In light of this, it's understandable that Cummins' P/E sits above the majority of other companies. Apparently shareholders aren't keen to offload something that is potentially eyeing a more prosperous future.

The Bottom Line On Cummins' P/E

Typically, we'd caution against reading too much into price-to-earnings ratios when settling on investment decisions, though it can reveal plenty about what other market participants think about the company.

We've established that Cummins maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. At this stage investors feel the potential for a deterioration in earnings isn't great enough to justify a lower P/E ratio. Unless these conditions change, they will continue to provide strong support to the share price.

Plus, you should also learn about this 1 warning sign we've spotted with Cummins.

If P/E ratios interest you, you may wish to see this free collection of other companies with strong earnings growth and low P/E ratios.

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