In November, Wall Street was abuzz as Warren Buffett said he would dish out $26 billion for a more than 75% ownership stake in railroad Burlington Northern Santa Fe (BNI). But now some investors are second guessing the Oracle of Omaha as the rail company offered a more pessimistic forecast. Many now fear industrial activity won’t be as robust as originally hoped and think Buffett’s bid for Burlington was premature.
While Burlington’s own management indeed lowered the bar, don’t be so fast to discount the entire sector on this news. The fact of the matter is that whatever the short-term troubles that are facing railroads, the long-term trends are clearly pointing to a surge in this sector. Here are five reasons you should be buying railroad stocks right now.
Reason #1 – Exports Are Booming
The U.S. trade deficit continues to narrow at a rapid pace. In the latest monthly figures, the trade gap fell to $32.9 billion as exports rose 2.6%, marking the sixth straight monthly gain. Railroad companies are a key part of the export chain, linking major ports to the rest of the continental U.S. and are benefiting strongly from this trend.
See also: Top 5 Stocks for January
This surge in exports is only going to continue in 2010. Thanks to a weak dollar, U.S. goods have become cheaper abroad and many businesses are seeing robust sales overseas. What’s more, America’s key exports include coal and soybeans, two commodities that are in high demand in Asia as economic growth continues at a breakneck pace. Trains are the primary means of transportation for coal from mines in Appalachia and soy from the Midwest, so railroad companies will win big as a result.
Reason #2 – Inventories Are Exhausted
In the depths of the recession, businesses slashed new orders to save capital and relied on sales of existing inventory. But no matter how much sales slow down, every store needs to have stock on the shelves to stay in business. We’ve seen businesses delay orders as long as possible, and now they are forced to place new orders simply because they have no inventory of goods or materials left.
Railroads are a key link in the chain to get goods from one part of the nation to another. This means that as inventories are rebuilt, railroads will see increased freight traffic and higher shipping rates.
Reason #3 – The Economy Is Recovering
Specific instances of inventories and exports aside, the entire economy is on the mend and that is boosting demand for all manner of goods and materials. Railroads are one of the first links in the supply chain for many goods, meaning that they will be some of the first companies to surge as the new bull market gains momentum.
Remember, someone has to ship the new cars to dealerships and the timber to paper mills and the oil to refineries. Cargo trucks and airplanes are simply not economical ways to transport large or heavy items, and railroads are sure to be lifted as the U.S. forges ahead in 2010 with continued growth.
Reason #4 – Earnings Are Improving
Though things certainly aren’t perfect for railroad companies, there is a strong upwards trend of profits from these companies. That means that now is the time to buy into railroad stocks and benefit from the buying pressure that is sure to follow another strong showing when fourth-quarter numbers are released in January.
Case in point: Industry icon Union Pacific (UNP) has seen earnings growth for each of the past three quarters and is forecasting another period of growth when it formalizes its Q4 numbers. Things are similar at CSX Corp. (CSX), which beating Wall Street estimates by an average of 14% across each of the last three quarters and is set to post another strong report at the end of January. Both of these stocks are just two examples of this broader trend across the railroad sector.
Reason #5 – Valuations Are Low
Perhaps the best reason to buy railroad stocks is because the boom is still ahead of us and valuations are very attractive. The cliche “buy low and sell high” rings very true in this case because most railroad companies have lagged the market’s recovery and are trading at bargain basement prices as we head into 2010.
A lot of people are bullish on technology companies, but the red-hot tech stocks are overheating with P/E ratios that are through the roof. Google (GOOG) has P/E of 40, and Amazon.com (AMZN) is at 80. Now compare that to Union Pacific (UNP), CSX Corp. (CSX) and Norfolk Southern (NSC), which all have a P/E ratio below 17. If you truly want to get more bang for your buck, buy these railroad stocks at a bargain instead of buying tech stocks at the top.