Has Union Pacific Become the Perfect Stock?

Every investor would love to stumble upon the perfect stock. But will you ever really find a stock that provides everything you could possibly want?

One thing's for sure: You'll never discover truly great investments unless you actively look for them. Let's discuss the ideal qualities of a perfect stock, then decide if Union Pacific (NYSE: UNP  ) fits the bill.

The quest for perfection
Stocks that look great based on one factor may prove horrible elsewhere, making due diligence a crucial part of your investing research. The best stocks excel in many different areas, including these important factors:

  • Growth. Expanding businesses show healthy revenue growth. While past growth is no guarantee that revenue will keep rising, it's certainly a better sign than a stagnant top line.
  • Margins. Higher sales mean nothing if a company can't produce profits from them. Strong margins ensure that company can turn revenue into profit.
  • Balance sheet. At debt-laden companies, banks and bondholders compete with shareholders for management's attention. Companies with strong balance sheets don't have to worry about the distraction of debt.
  • Money-making opportunities. Return on equity helps measure how well a company is finding opportunities to turn its resources into profitable business endeavors.
  • Valuation. You can't afford to pay too much for even the best companies. By using normalized figures, you can see how a stock's simple earnings multiple fits into a longer-term context.
  • Dividends. For tangible proof of profits, a check to shareholders every three months can't be beat. Companies with solid dividends and strong commitments to increasing payouts treat shareholders well.

With those factors in mind, let's take a closer look at Union Pacific.

Factor

What We Want to See

Actual

Pass or Fail?

Growth

5-Year Annual Revenue Growth > 15%

5.3%

Fail

 

1-Year Revenue Growth > 12%

13.1%

Pass

Margins

Gross Margin > 35%

43.4%

Pass

 

Net Margin > 15%

18.2%

Pass

Balance Sheet

Debt to Equity < 50%

49.3%

Pass

 

Current Ratio > 1.3

1.01

Fail

Opportunities

Return on Equity > 15%

20.0%

Pass

Valuation

Normalized P/E < 20

16.12

Pass

Dividends

Current Yield > 2%

1.9%

Fail

 

5-Year Dividend Growth > 10%

28.5%

Pass

       
 

Total Score

 

7 out of 10

Source: S&P Capital IQ. Total score = number of passes.

Since we looked at Union Pacific last year, the company has lost a point. But much of the reason for the score drop is the big gain in the stock, with a 40% jump in share price in the past year helping to push the dividend yield down below the key 2% level.

For years, railroad stocks performed uniformly well. With high energy prices, more efficient rail transportation led to lower costs, spurring new demand. As the largest hauler of freight in the industry, Union Pacific has particularly benefited from the trend.

More recently, though, the changing macroeconomic environment has led to a split among railroad companies. On one hand, Union Pacific's emphasis on the western half of the U.S. market has given it continued success, along with Canadian railroads Canadian Pacific (NYSE: CP  ) and Canadian National (NYSE: CNI  ) , as continued development of Canada's natural resources has led to a transportation boom there. But in the eastern U.S., CSX (NYSE: CSX  ) and Norfolk Southern (NYSE: NSC  ) have struggled as the dramatic reduction in coal prices has led to reduced shipments in the Appalachian region.

One way Union Pacific has fought the railroad industry downturn is by finding new things to deliver. For instance, the railroad has boosted its shipments of lumber and homebuilding products lately, boding well for the housing market. Yet Union Pacific is also trying to represent itself more as a logistics solutions business, with an ad campaign to match.

For Union Pacific to keep improving, it needs to see energy prices remain high, and it would benefit from renewed growth in China and other Asia-Pacific markets. If it gets those tailwinds, Union Pacific could move close to perfection in the near future.

Keep searching
No stock is a sure thing, but some stocks are a lot closer to perfect than others. By looking for the perfect stock, you'll go a long way toward improving your investing prowess and learning how to separate out the best investments from the rest.

Union Pacific may not be perfect, but we've got some other ideas you might like better. Let me invite you to learn about three smart long-term stock plays in the Fool's latest special report. It's yours for the taking and is absolutely free, but don't miss out -- click here and read it today.

Click here to add Union Pacific to My Watchlist, which can find all of our Foolish analysis on it and all your other stocks.

Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. Motley Fool newsletter services have recommended buying shares of Canadian National Railway. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.


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