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Stock Strategist Industry Reports

Railroads' Competitive Advantages Are Solid, but Challenges Lie Ahead

Containers, coal, crude, and codes are investors' current concerns.

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A century ago, railroads accounted for more than 60% of the total U.S. stock market valuation--about the same share of today's combined value of technology, industrials, health care, banks, and utilities companies. Today, the railroads' share of that figure has diminished to less than 1%. Anchored by secular margin improvement and powerful competitive advantages, they still attract investor interest.

However, bargains are scarce: Of the railroad stocks we cover, two are priced attractively enough to provide a margin of safety sufficient to garner our 4-star rating ( Union Pacific (UNP) and  Norfolk Southern (NSC)). Quality is rarely on sale, and we consider the quality of all of these railroad enterprises to be outstanding. Railroads benefit from wide economic moats based on the cost advantages they offer over other freight transportation modes and the efficient scale of a market that generally has only two rational competitors per geographic region. Today, railroad investors must evaluate four overarching themes: (1) The secular volume driver will be intermodal containers. (2) The secular volume loser will be coal carloads. (3) New energy and crude volume may generate short-term media attention and move short-run share prices, but the long-run volume potential may be decidedly more muted. (4) Regulatory codes and laws continue to influence operations and expenses.

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Keith Schoonmaker does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.