What are we looking for?
North American railway stocks with compelling valuations and growth prospects.
Last week's collapse in the price of oil hit many stock market sectors hard, including transportation stocks such as railways. Although diesel fuel is a factor in railways' operating costs, investors are concerned that declining oil shipments by rail may hit future revenue. Last week's selloff may have created compelling valuation levels, especially in light of an improving North American economy in 2015.
The screen
We will be using Recognia Strategy Builder to search for North American railway stocks with strong growth prospects and reasonable valuations.
We begin by setting a maximum price-to-earnings ratio (P/E) of 30 to limit our search to railway stocks with reasonable valuation levels. We will also select only companies with efficient operations as measured by their operating margins. Operating margin is a measure of how much profit a company makes for each dollar of revenue. We will select only companies with operating margins of greater than 25 per cent.
Next, we will look for companies that have low debt levels as measured by their debt-to-equity ratios. High debt levels may be problematic for companies should interest rates begin to move up in the future. We will screen for companies with debt to equity ratios of 1.0 or less.
Finally, to select stocks with strong growth prospects, we will screen for earnings-per-share growth of at least 5 per cent annually measured over the past five years.
More about Recognia
Recognia is a global leader in quantitative and technical analysis. It is accessible by more than 20 million investors and traders worldwide through leading retail online brokers. Recognia covers 85 exchanges worldwide, and analyzes 72,000 instruments daily including stocks, indexes, ETFs, currencies and futures.
What did we find?
Norfolk Southern Corp. is North America's fourth-largest railway and ranks No. 1 on our list. Operating mainly in the eastern U.S., Norfolk Southern has the lowest P/E ratio on our screen at 17.1 and has five-year historical EPS growth of 20 per cent annually.
Kansas City Southern is the smallest of the U.S. Class I railways and operates mainly in the central U.S. and in Mexico. The company has the strongest EPS growth rate on our list at 41.1 per cent. In October, the company announced third-quarter earnings which beat expectations and confirmed the belief of many analysts that the railway sector could continue to outperform in coming months.
Canadian National Railway Co. serves Canada as well as the central and southern U.S. It is one of North America's most efficient operators with an operating margin of 45.6 per cent. In spite of the stock rising over 26 per cent in the past 12 months, CN still has a P/E ratio of 18.3, which is reasonable compared to its peers.
Historical performance
Recognia Strategy Builder provides a backtesting capability to evaluate how well an investing strategy would have worked in the past. Using a five-year historical period with quarterly rebalancing, the screen described had a 27.5 per cent annualized return compared to 13.3 per cent for the S&P 500 and 4.8 per cent for the S&P/TSX 60 index.
The investment ideas presented here are for information only. They do not constitute advice or a recommendation by Recognia Inc. in respect of the investment in financial instruments. Investors should conduct further research before investing.
Peter Ashton is vice-president of retail and self-directed investing at Recognia Inc.