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The Most Promising Dividends in Railroads

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Dividend payers deserve a berth in any long-term stock portfolio. But seemingly attractive dividend yields are not always as fetching as they may appear. Let's see which companies in the railroad industry offer the most promising dividends.

Yields and growth rates and payout ratios, oh my!
Before we get to those companies, though, you should understand just why you'd want to own dividend payers. These stocks can contribute a huge chunk of growth to your portfolio in good times, and bolster it during market downturns.

As my colleague Matt Koppenheffer has noted: "Between 2000 and 2009, the average dividend-adjusted return on stocks with market caps above $5 billion and a trailing yield of 2.5% or better was a whopping 114%. Compare that to a 19% drop for the S&P 500."

When hunting for promising dividend payers, unsophisticated investors will often just look for the highest yields they can find. While these stocks will indeed pay out the most, the yield figures apply only for the current year. Extremely steep dividend yields can be precarious, and even solid ones are vulnerable to dividend cuts.

When evaluating a company's attractiveness in terms of its dividend, it's important to examine at least three factors:

  • The current yield.
  • The dividend growth.
  • The payout ratio.

If a company has a middling dividend yield, but a history of increasing its payment substantially from year to year, it deserves extra consideration. A $3 dividend can become $7.80 in 10 years, if it grows at 10% annually. (It will top $20 after 20 years.) Thus, a 3% yield today may be more attractive than a 4% one, if the 3% company is rapidly increasing that dividend.

Next, consider the company's payout ratio, which reflects what percentage of income the company is spending on its dividend. In general, the lower the number, the better. A low payout ratio means there's plenty of room for generous dividend increases. It also means that much of the company's income remains in its hands, giving it a lot of flexibility. That money can fund the business's expansion, pay off debt, buy back shares, or even buy other companies. A steep payout ratio reflects little flexibility for the company, less room for dividend growth, and a stronger chance that if the company falls on hard times, it will have to reduce its dividend.

Peering into railroads
Dividend investors typically focus first on yield. Guangshen Railway (NYSE: GSH  ) and Norfolk Southern (NYSE: NSC  ) are the highest-yielding stocks among railroad companies, recently offering 4.4% and 2.7%, respectively. But they're not necessarily your best bets, as their dividend growth rates are not as high as others. (Their payout ratios are low, though, as are all in the industry, suggesting lots of room for growth.)

Guangshen isn't a household name in the U.S., but it operates in China's most populous province, and moves freight, as well. Chinese companies face extra risks, such as the possibility of the government interfering with operations, but it also offers an economy growing considerably faster than America's.

Norfolk Southern has many of the marks of a perfect stock, and it dominates in the American South, where much of our economic growth potential lies. As our economy recovers, rail traffic will increase, as it's much more cost-effective than trucking with high energy prices. The company is an environmental leader, as well, operating its trains on renewable diesel fuel and developing hybrid locomotives, too.

If you focus on the dividend growth rate instead, you'll end up with Union Pacific (NYSE: UNP  ) , which sports a five-year average annual dividend growth rate of 41%. It's important to recognize that such a steep rate won't be sustainable for long, though the company's payout ratio of 29% suggests that it needn't rein in growth too quickly. It has a lot to recommend itself, too, such as a lower debt level than some peers. Like all railroad companies, the low price of natural gas has put some pressure on growth, shrinking demand for coal (and, thus, the transportation of coal).

Just right
As I see it, CSX (NYSE: CSX  ) and Guangshen Railway offer the best combination of dividend traits, sporting some solid income now and a good chance of strong dividend growth in the future. CSX's yield was recently 2.5%, and it has been hiking it by an average of 18% annually, lately. It has been posting solid results and investing heavily in its future, including some intermodal projects that will boost its flexibility and growth prospects.

Consider others in the industry, as well, though, such as Canadian National Railway (NYSE: CNI  ) , with a recent yield near 1.7% and average growth of 13%. It recently hit a 52-week high, and reported second-quarter revenue up 13% and earnings up 19%. Management noted that, "We moved more traffic than we ever have before, handling on average over 1 billion GTMs [gross tons per mile] per day. Intermodal, Automotive, Coal, Petroleum and Chemicals, and our Metals and Minerals business units all registered double-digit gains."

Of course, as with all stocks, you'll want to look into more than just a company's dividend situation before making a purchase decision. Still, these stocks' compelling dividends make them great places to start your search, particularly if you're excited by the prospects for this industry.

Do your portfolio a favor. Don't ignore the growth you can gain from powerful dividend payers.

These are not your only options, of course, if you're seeking big dividend yields. Check out our special free report right now: "Secure Your Future With 9 Rock-Solid Dividend Stocks."

Longtime Fool contributor Selena Maranjian, whom you can follow on Twitter, owns shares of Canadian National Railway, but she holds no other position in any company mentioned. Click here to see her holdings and a short bio. Motley Fool newsletter services have recommended buying shares of Canadian National Railway. The Motley Fool has a disclosure policy.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Read/Post Comments (4) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 16, 2012, at 4:02 PM, prginww wrote:

    Own NSC! Intermodal taking business from trucks big time because of clogged and dangerous highways. BNSF owned 100% by Warren, and he paid a premium to get it. Good enough for him, good enough for me.

  • Report this Comment On August 16, 2012, at 6:46 PM, prginww wrote:

    CNI has been a beast for me. Very happy with that investment.

  • Report this Comment On August 19, 2012, at 11:29 PM, prginww wrote:

    " handling on average over 1 billion GTMs [gross tons per mile] per day"

    Okay, lets say there are two towns 100 miles apart. Then every day they move 100 Billion gross tons down that track. Lets say a coal car weighs 50 tons and can carry 50 tons of coal = 100 gross tons. That means they move One Billion coal cars down that track every day. I don't think so.

    Being good at math cuts through BS.

  • Report this Comment On August 23, 2012, at 9:34 PM, prginww wrote:

    Do you pay Chinese tax on the 4.4 % dividend from GSH?

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