Investing in Railroad Stocks

Railroad stocks were responsible for one of the first big investment booms in U.S. history. More than a century later, railroads remain a key part of the economy. Railroad stocks offer ownership in the companies that operate in the railway industry. Over the years, the industry has consolidated to a handful of titans responsible for moving most of the goods around the country and to and from ports.

As shippers and truckers faced disruptions during the COVID-19 pandemic, railroads held up better than most because of their unique 24/7 business model and ability to move a lot of cargo with very few people. And in an age where fuel efficiency is increasingly a priority, railroads are only growing in importance as the transportation solution of choice.

Transportation stocks tend to be cyclical, but rail holds up better than most in an economic downturn because rail companies are larger and better capitalized than trucking companies. Despite high oil prices leading to higher fuel bills, railroads also tend to do well when fuel costs spike because trains can transport a lot more cargo than trucks for each gallon of diesel burned.

For much of the 20th century, the railroad industry was plagued by bankruptcies. But today, thanks to years of consolidation and a recent push known as Precision Scheduled Railroading, the remaining companies are able to get more from their assets. The changes have brought down costs throughout the industry and allowed the companies to return more cash to shareholders.

5 railroad stocks to buy right now

1. Union Pacific

Union Pacific is one of two large railroads operating in the western half of the country. Its track connects the ports of Los Angeles and Long Beach with U.S. population centers. Union Pacific has long had a reputation among investors as the best-run U.S. railroad, with vast stretches of track through rural areas and connections to western energy assets.

Like most railroads, Union Pacific pays a dividend, with the stock yielding about 2.1% at the time of this writing. Over the past five years, the railroad has increased revenue at a compound annual rate of about 2.2%. The company is also in the middle of an extensive cost cutting campaign orchestrated by Jim Vena, who took over as CEO in 2023.

2. Canadian Pacific

Canadian Pacific was historically the smaller of the two major Canadian railroads. That changed with the company's 2023 acquisition of Kansas City Southern. The deal gave Canadian Pacific a vast network down the spine of North America to a deep-water port in Mexico. This network, coupled with its existing east-west track across Canada, allows freight to travel around the continent seamlessly.

Railroad mergers have a long history of getting off-track, and investors should tread cautiously during what is likely to be a multiyear integration process. But if all goes according to plan, the new Canadian Pacific Kansas City can be a new North American transportation powerhouse.

3. Canadian National

Canadian National has been public only since the mid-1990s, but the government entity-turned-private company provides access to almost every corner of Canada and a shipping link to the Gulf of Mexico. The railroad has more than 20,000 route miles of track and hauls agricultural products, energy, and containers from coast to coast.

Canadian National offers something that its U.S. counterparts can't match: Access to both the Atlantic and Pacific oceans, as well as all of the geography in between. The company is well-positioned to benefit from strong demand for Canadian energy assets and the impact of companies bringing their supply chains to North America.

4. CSX

CSX is primarily focused east of the Mississippi River, with more than 20,000 miles of track and access to 70 ports. Due to the more congested landscape, East Coast railroads have historically been less efficient than their Canadian and Western counterparts.

Still, CSX has made great strides in recent years in improving its operations. CSX has delivered compound annual growth of more than 9% over the past five years.

CSX has officially existed only since 1980, but it is a combination of a number of railroads that have been around since the dawn of the U.S. rail age, including the Baltimore & Ohio, the oldest in the nation. The company faces the challenge of maintaining and modernizing many century-old assets along the rails, but it has still generated reliable profits.

5. Norfolk Southern

Norfolk Southern is the other Eastern-focused railroad, operating more than 19,000 track miles across 22 states and the District of Columbia. The company is a major transporter of industrial, agricultural, and consumer products and is a primary source of transportation for coal and auto parts. Norfolk Southern also has an extensive intermodal network in the East that carries containers from ship hulls to truck flatbeds.

Norfolk Southern's revenue has grown at a 12% annualized rate over the past five years, and its dividend currently yields more than 2.1%. The company has hiked its dividend four times since the beginning of 2021 and doubled its share repurchase target. In years to come, Norfolk Southern plans to return between 35% and 40% of net income to shareholders through continued dividends.

One other "railroad company" is a lot more than railroading

Another railroad competes against Union Pacific out West, but it is hidden inside the massive portfolio of Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B). In 2009, Berkshire Hathaway bought full control of Burlington Northern Santa Fe (BNSF), giving it ownership of North America's largest railroad. BNSF operates more than 32,500 miles of track in 28 states and three Canadian provinces.

BNSF's earnings make up only a small fraction of Berkshire Hathaway's overall revenue, and it would be unwise to buy Berkshire solely for its railroad. But for investors looking for exposure to rail in a diversified package, Berkshire Hathaway could be an attractive investment.

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Are railroad stocks right for you?

Rail can be plodding, but it does deliver. In a world where the supply chain is under pressure and fuel efficiency is king, rail is well positioned to take an ever-expanding part of the transportation pie in years to come.

• Rail offers the ability to haul a lot more cargo than other transportation methods with just a handful of employees
• Unlike trucking, rail has a 24/7 operating model
• Rail companies are reliable dividend payers

These railroad companies provide a steady stream of income, reliable cash flows, and modest but sustainable revenue growth. Railroad stocks can be an attractive way to diversify for investors looking to keep a growth-focused portfolio on the rails when tech stocks are out of favor.

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