With the United State's economic situation finally beginning to move in the right direction, freight traffic has been picking up steam. Tracking a variety of transportation companies including trucking, marine and air traffic, the iShares Dow Jones Transportation Average (NYSE:IYT) has rallied nearly 23% in the last 12 months. However, one group has performed even better.

IN PICTURES: 9 Simple Investing Ratios You Need To Know

The North American railroads have dramatically improved their margins since the so-called "rail renaissance" that began in the mid-2000's and are poised to take advantage of the continuing economic growth. Overall rising demand for commodities has helped the sector rebound from 2009 recession lows. This, combined with the continued focus on the nation's infrastructure, means that rail traffic will be in demand. Investors looking for a way to play the increasing economic growth should take notice of the sector.

Freight Rebound
Overall, the North American railroads experienced increases in hauling traffic throughout 2010. Total carloads increased 7.3% and intermodal volume increased by nearly 14.2% throughout the year. While the data is still below levels achieved in 2008, the current year's numbers are showing signs of improvement. Through 2011's first seven weeks, carloads were up 5.1% and trains shipped 1.9 million containers, up 8.4% compared with traffic from the same period in 2010. Currently railroads ship less than half of the freight in America, leaving plenty of room for growth. This increase in shipping has many analysts bullish on the railroad sector and economy in general. Analyst's estimate that railroad revenue growth should exceed that of U.S. GDP for the next three to six years.

Railroads are also benefiting from high crude oil and gasoline prices. Trains are more fuel efficient than traditional diesel trucking so moving goods by rail reduces greenhouse omissions, especially as the industry continues to improve on engine design. Railroad companies have doubled their efficiency since 1981, plowing more than 40 cents per dollar they earn, back into their networks. Freight railroads have invested more than $460 billion since 1980 to maintain and improve their tracks, bridges, tunnels, locomotives, freight cars, and other infrastructure and equipment. Estimates by the Association of American Railroads suggest that it would cost shippers almost $70 billion more per year if all freight moved by rail were shifted to truck.

These infrastructure and improvement investments have provided an increase in rail productivity by 174% since 1981 and average inflation-adjusted rail rates decrease of 55%.

Getting a Ticket to Ride
As consolidation in the industry has been rampant over the last few years - Berkshire Hathaway's (NYSE:BRK.B) mega-purchase of Burlington Northern-Santa Fe Railway comes to mind - only a handful of railroad providers are left. However, despite their strong runs over the last year, the sector is still undervalued. Forward P/E's for the sector trade at an average 12, below the normal 15. In addition, the overall sector pays consistent growing dividends, even raising payments during the recession. Investors looking for value among the stock market's recent run-up should consider the railroad sector.

Criss-crossing 23 different states, Union Pacific (NYSE:UNP) is the nation's largest railroad. Capital spending totaled $2.5 billion in 2010 and has helped UNP become one of the most efficient railroad stocks with an operating margin of 29.4%. Analysts expect 13% revenue growth in 2011. In addition, Union Pacific raised its dividend 41% during the recession. Similarly, CSX (NYSE:CSX) has rapidly been improving their operating margins as well.

Offering the sectors highest dividend yield, Kansas City Southern (NYSE:KSU) recently reported a double digit growth expectation. Norfolk Southern, another major player, operates one of the most extensive intermodal networks in the East and is a major transporter of coal and industrial products.

Orders for new railway freight cars rose to 10,853 in the fourth quarter. Finally, any increased rail traffic will benefit the producers of rail cars, tracks, ties and other industrial equipment used in the sector. Both American Railcar Industries (Nasdaq:ARII) and FreightCar America (Nasdaq:RAIL) both manufacture various railcars and will profit from the long term increase.

Bottom Line
As the economy continues to improve, so should the returns of the railroad operators. The sector is cheap based on historical measures and is experiencing increases in freight traffic. For investors looking for values among the market's recent rise, railroad stocks such as Genesee & Wyoming (NYSE:GWR) make ideal portfolio positions. (Without this risk-reduction technique, your chance of loss will be unnecessarily high. See The Importance Of Diversification.)

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Investing

    Time to Bring Active Back into a Portfolio?

    While stocks have rallied since the economic recovery in 2009, many active portfolio managers have struggled to deliver investor returns in excess.
  2. Chart Advisor

    Now Could Be The Time To Buy IPOs

    There has been lots of hype around the IPO market lately. We'll take a look at whether now is the time to buy.
  3. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  4. Chart Advisor

    Copper Continues Its Descent

    Copper prices have been under pressure lately and based on these charts it doesn't seem that it will reverse any time soon.
  5. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  6. Mutual Funds & ETFs

    Buying Vanguard Mutual Funds Vs. ETFs

    Learn about the differences between Vanguard's mutual fund and ETF products, and discover which may be more appropriate for investors.
  7. Mutual Funds & ETFs

    ETFs Vs. Mutual Funds: Choosing For Your Retirement

    Learn about the difference between using mutual funds versus ETFs for retirement, including which investment strategies and goals are best served by each.
  8. Mutual Funds & ETFs

    How to Reinvest Dividends from ETFs

    Learn about reinvesting ETF dividends, including the benefits and drawbacks of dividend reinvestment plans (DRIPs) and manual reinvestment.
  9. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  10. Mutual Funds & ETFs

    Best 3 Vanguard Funds that Track the Top 500 Companies

    Discover the three Vanguard funds tracking the S&P 500 Index, and learn about the characteristics and historical statistics of these funds.
  1. Should mutual funds be subject to more regulation?

    Mutual funds, when compared to other types of pooled investments such as hedge funds, have very strict regulations. In fact, ... Read Full Answer >>
  2. Do ETFs pay capital gains?

    Exchange-traded funds (ETFs) can generate capital gains that are transferred to shareholders, typically once a year, triggering ... Read Full Answer >>
  3. How do real estate hedge funds work?

    A hedge fund is a type of investment vehicle and business structure that aggregates capital from multiple investors and invests ... Read Full Answer >>
  4. Are Vanguard ETFs commission-free?

    While some Vanguard exchange-traded funds (ETFs) are available commission-free from third-party brokers, a large portion ... Read Full Answer >>
  5. Do Vanguard ETFs require a minimum investment?

    Vanguard completely waives any U.S. dollar minimum amounts to buy its exchange-traded funds (ETFs), and the minimum ETF investment ... Read Full Answer >>
  6. Can mutual fund expense ratios be negative?

    Mutual fund expense ratios cannot be negative. An expense ratio is the sum total of all fees charged by an asset management ... Read Full Answer >>

You May Also Like

Trading Center