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An American Success Story: Innovation Driving Profits

Friday, May 4th, 2012
By for Profit Confidential

Innovation Driving ProfitsWhen it comes to investment strategy, many U.S.-based firms simply take the approach of blaming cheap foreign labor everywhere else and throwing up their hands as if there’s nothing they can do. That’s not much of a long-term investing strategy. There are some examples of U.S.-based firms that are generating strong corporate profits with a unique investment strategy—providing innovative products that customers really want.

Cummins Inc. (NYSE/CMI) is one such American firm that has seen rising corporate profits and has an intelligent investment strategy. Cummins produces engines for trucks and machines. Some might think: how can a U.S.-based firm increase corporate profits by building an engine when foreign competitors must be able to do it cheaper? The answer is: good old-fashioned innovative designs developed with an investment strategy to provide customers with a superior product. Demand for engines built by Cummins continues to grow around the world.

Cummins’ investment strategy is to become the leader in producing innovative, high-quality goods. This vision is not short-term thinking, but rather an investment strategy built carefully over time that is now paying off in strong corporate profits.

Thirty-five percent of sales for Cummins came from emerging markets like India, China, Brazil and other smaller nations. In 2007, this number was 27%. While corporate profits have been strong, the latest quarterly results are showing some weakness in these emerging markets, as revenue declined 16% in China and 18% in Brazil. While these declines will hurt short-term corporate profits, the firm has a long-term investment strategy with a long-term vision over the next decade.

In the short term, cautious comments by the CEO, N. Thomas Linebarger, might indicate that a pullback is in order; the CEO stated that he doesn’t believe any economy is going to do well in the near term. Cummins estimates that these emerging markets over the next 10 years will grow more than double what the U.S. and Europe will return.

A benefit of having an investment strategy built on a strong product is that the name Cummins has now become synonymous with high-quality products, which drives corporate profits. In 2011, income increased 78% from 2010. First-quarter profits of 2012 were $455 million, up 33% from 2011. The CEO states that the investment strategy for Cummins over the next several years is to achieve $30.0 billion in annual sales and $20.00 a share in corporate profits, a very lofty goal in a weakening global environment.

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The other advantage Cummins has is that it’s a natural gas benefactor as well. Cummins is one of the leaders in converting diesel truck engines into natural-gas-powered engines, another division that’s seeing growth in corporate profits. As the price of natural gas remains low, the conversion of existing diesel engines to natural gas will drive corporate profits, a smart long-term investment strategy.

One of the most interesting statements I heard from the CEO was: “Whatever your technology offering is now, next year’s has to be better.” A great statement, showing that Cummins is focused on innovation as a core investment strategy.

Cummins Inc. NYSE-CMI ChartChart courtesy of www.StockCharts.com

The recent high in March is showing a negative divergence, as the Relative Strength Index (RSI) and the Moving Average Convergence Divergence (MACD) Line did not correspond with highs of their own, a bearish sign. The stock is now trading below the median uptrend line, which usually indicates a possibility of trading down near or below the lower uptrending line. Fibonacci retracements show a support level of approximately $102.00 and, if that breaks, long-term support at the $85.00 area. Considering some of the negative comments by the CEO on weakening emerging markets and world economy, I can see this stock selling off for a period of time. Some of these comments echo what I found in my research of Caterpillar Inc. (NYSE/CAT), which you can read about in Caterpillar’s Cracks Indicate an Economic Slowdown.

Cummins appears poised for a short-term pullback. However, the investment strategy over the long term appears quite solid. More U.S. companies need to take a page from Cummins investment strategy to drive corporate profits by innovating and providing extremely high-quality products that are the leaders in each category. The goal of a company should be to have its name synonymous with high quality in the mind of the consumer. This investment strategy will enable high margins and strong corporate profits over the long term.

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Sasha Cekerevac - Investment Advisor, Fund AnalyzerSasha Cekerevac, BA Economics with Finance specialization, is a Senior Editor at Lombardi Financial. He worked for CIBC World Markets for several years before moving to a top hedge fund, with assets under management of over $1.0 billion. He has comprehensive knowledge of institutional money flow; how the big funds analyze and execute their trades in the market. With a thorough understanding of both fundamental and technical subjects, Sasha offers a roadmap into how the markets really function and what to look for as an investor. His newsletters provide an experienced perspective on what the big funds are planning and how you can profit from it. He is the editor of several of Lombardi’s popular financial newsletters, including Payload Stocks and Pump & Dump Alert. Add Sasha Cekerevac to your Google+ circles