Union Pacific, a Totally Cool Stock

Leading the Vanguard Windsor Fund, John Neff beat the market by more than three percentage points per year for more than 30 years. That's an incredible track record and the difference between $39,116 and $17,449 on a $1,000 investment, assuming a 10% average return. Here's the master's secret: Two of those three percentage points came from dividends. So while Neff worked hard to buy cheap stocks, dividends were crucial to outsized returns. That's totally cool!

To help find totally cool stocks that offered value and income, Neff used his total return ratio, defined as:

Total Return Ratio = (analysts' expected earnings growth rate + dividend yield) / price-to-earnings ratio

Neff would compare company ratios to the market's ratio. If a company's ratio was at least 50% greater than the market's, he gave it look. If Neff’s research revealed the market misinterpreted the company's prospects and thus created an opportunity, he purchased shares for the portfolio.

Currently, the market's total return ratio is about 0.95. (I used a Shiller P/E of 20.1, a yield of 2%, and two-year estimated earnings growth of 17.2%.) So to meet Neff's criteria, a company's ratio must be greater than 1.43.

Let's look at the table below to see if Union Pacific (NYSE: UNP  ) might be a total return opportunity.

Company

2-Year Growth Est. (%)

Yield (%)

P/E

Total Return Ratio

Union Pacific Corp.

28.1

1.7

17.1

1.63

Norfolk Southern Corp. (NYSE: NSC  )

26.8

2.5

17.3

1.55

CSX Corp. (NYSE: CSX  )

23.0

1.8

16.0

1.43

According to the numbers in the table, Union Pacific looks more attractive than competitors Norfolk Southern and CSX. However, a quick look at the table shows they are all solid opportunities with CSX brining up the rear right at the cutoff. Union Pacific just happens to be the best one of the bunch.

The Foolish bottom line
Neff's total return ratio is beautiful because it combines value and income: cheap stocks with dividend kickers. Investors can profit from multiple expansion while collecting dividend payments along the way. And as Neff showed, done correctly, this strategy can lead to excess returns over the market. As with any metric, Neff’s total return ratio is just a starting point. But with a total return ratio of 1.63, Union Pacific certainly seems like a totally cool stock to get to know.

Million Dollar Portfolio associate advisor David Meier does not own shares of any of the companies mentioned. He does know that Income Investor has plenty of great ideas that can generate excellent total returns. You can take a trial here. The Motley Fool has a disclosure policy.


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