It's Time To Invest In Railroad Stocks

By Investopedia Staff | January 27, 2012 AAA

Railroads have been of a central part of the United States economy for centuries. In the beginning railroads were the titans of technology, transforming the world in a similar way that companies like Apple and Google are doing today. Railroads changed the way people traveled, the speed of information, and promoted the rapid growth of cities. Fast forward to today and railroads are once again in vogue, albeit for slightly differing reasons.

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Basic Economics
Basic economics tells us that when a similar good or service can be provided at a lower price, customers will gravitate towards the source providing the lower price. When it comes to railroads, they are a cheaper and cleaner form of transportation than any other ground alternative. On average, railroads are three times more fuel efficient than trucks. In 1980, U.S. railroads moved a ton of freight an average of 235 miles per gallon of fuel. Twenty years later, the comparable figure was 404 miles, a 72% increase. A single inter modal train has the equivalent capacity of 280 trucks; rails are better for the environment and help alleviate highway congestion. On top of that, railroads possess significant safety advantages over trucks especially when it comes to the transportation of hazardous materials.

How Investors Benefit?
So what do the above advantages of railroads over trucks mean for investors? If you believe that over time, fuel costs are going to go up and that businesses will look for more efficient ways to transport their goods, then railroads are going to be winners for a long-time coming. As fuel costs rise, the economics of rail transport over trucks grows significantly. Railroads can also handle vastly more freight per employee. And if the U.S. economy remains stuck in a low-growth environment, rail transportation becomes even more attractive to customers looking to trim costs.

CSX (NYSE:CSX), Norfolk Southern (NYSE:NSC) and Union Pacific (NYSE:UNP) make up the "big three" as the largest publicly traded players in the game after the acquisition of Burlington Northern by Berkshire Hathaway in 2009. They all trade at reasonable valuations today of between 13 and 17 times trailing earnings. Earnings estimates for all three see quality profit growth in 2012. The dividend yields are decent, ranging from 2% to 2.5%. Kansas City Southern (NYSE:KSU) is the smallest of the Class I railroads, a classification assigned to the biggest rails in terms of revenue. It boasts a market cap of $7.5 billion but is being valued at 23 times trailing earnings and pays no dividend. Yet KSC serves some valuable port cities especially in Mexico where freight traffic is growing at a higher rate than in the US.

The Bottom Line
The investment story behind rails is not new. Share prices have advanced rapidly since the economy pulled out of the recession. Short-term traders may not want to look at the rails. But the long-term picture remains solids due to the economic advantages that rails possess over trucking. (For additional reading, take a look at A Primer On The Railroad Sector.)

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