Ask the Rational Investor: Investing in Predictable Railroads
An investment philosophy is an important and often overlooked part of any portfolio. Our firm focuses on investing in large, predictable, and highly profitable businesses that have a track record of allocating capital towards dividends, share repurchases, and internal investment.
When we are assessing a company, we review upwards of 20+ years of company data and question how the company’s competitive positioning has generated historical results. As well as how future industry dynamics will impact the company going forward.
One sector where competitive positioning stays relatively constant is the railroad industry. When examining an industry one of the first areas we tend to look at are gross margins. High gross margin businesses tend to have extreme pricing power and few competitors.
Another factor we focus on is the after-tax profit margins of an industry and potential investment. The S&P 500’s net margins are about 12% and most large businesses operate close to this level, but few exceptional businesses can be much higher in the range of 20 to 40%.
One example would be the railroad industry where the average net margin is about 28% or more than double that of the broad stock market. Simply put there is only so much physical rail across America and these routes are often semi-exclusive, which results in great profitability.
Union Pacific Railroad has consistently been one of the best-operated railroads and consistently has allocated capital toward shareholders through dividends and buybacks.
Over the last five years, the company has generated capital of over $130 billion deploying 32% towards dividends and share repurchases. These allocation decisions resulted in the share count declining 22% and shareholders receiving $12 billion in dividends.
Based on history and management’s communicated capital allocation priorities we expect similar trends to occur over the next 4 years with approximately $164 billion in capital being generated and similar amounts being allocated to shareholders. These decisions should result in a steadily growing dividend and a shrinking share count.
Finding a great business is challenging but finding one attractively valued is even harder.
Instead of valuing Union Pacific on traditional metrics such as price-to-earnings or enterprise value to EBITDA looking at the relative dividend yield to the S&P 500 is useful. On this metric, the company is trading at its cheapest valuation in the last 15 years.
Every investor’s goals and risk tolerance are unique and they should consult with their portfolio manager prior to investing.
Beese Fulmer Private Wealth Management was founded in 1980 and is one of Stark County’s oldest and largest investment management firms. The company serves high-net-worth individuals, families, and non-profits, and has been ranked as one of the largest money managers in Northeast Ohio.
Past performance is not indicative of future results. The material above has been provided for informational purposes only and is not intended as legal or investment advice or a recommendation of any particular security or strategy. The investment strategy and themes discussed herein may be unsuitable for investors depending on their specific investment objectives and financial situation. Information obtained from third-party sources is believed to be reliable though its accuracy is not guaranteed, Beese Fulmer Private Wealth Management ("Beese Fulmer") makes no representation or warranty as to the accuracy or completeness of the information, which should not be used as the basis of any investment decision. Information contained on third-party websites that Beese Fulmer may link to is not reviewed in their entirety for accuracy and Beese Fulmer assumes no liability for the information contained on these websites. Opinions expressed in this commentary reflect subjective judgments of the author based on conditions at the time of writing and are subject to change without notice. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission from Beese Fulmer. For more information about Beese Fulmer, including our Form ADV brochures, please visit https://adviserinfo.sec.gov and search for our firm name.
