Beat the Market With This "Boring" Top 10 Stock

Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

There are lots of ways to beat the market. While fantastic growth stories like Apple and 3D Systems get a lot of attention, investors in "boring businesses" like Coca Cola and Costco Wholesale have outperformed the market as well in recent years. In the seventh installment of a series identifying ten great businesses that should be considered for any investor's portfolio, today's top 10 stock is in an industry that is about as boring as they come to investors: railroads. 

Time to take notice of railroads

Most people tend to think of railroads as obsolete businesses that are in a permanent decline thanks to airplanes and automobiles. What this mentality fails to consider is the fact that rail remains an extremely cost effective way to transport raw materials (including natural resources ranging from oil to lumber) to businesses and then shipping finished goods in bulk to distributors. Rail is also a preferred method of bridging the gap between imported goods unloaded at a seaport and the products' final destination. The necessity of this industry to the global economy and its resilience to the "Great Recession" is evident in the performance of Canadian National Railway (NYSE: CNI) and its peers in recent years:

CNI data by YCharts

With this background in mind, there are a few reasons that CN is a superior choice amongst railroad companies. CN's network of over 20,000 track miles has a uniquely positioned backbone that connects North America's three coasts: the Pacific Ocean, Atlantic Ocean, and Gulf of Mexico. Through its ports on these three coasts, CN is able to not only compete for traffic from concentrations of natural resources in Canada and the Midwest to local production facilities, but also handle end-to-end solutions for items being imported into and exported from North America in any direction. When combined with a unique focus on efficiency described by CN CEO Claude Mongeau as "precision railroading," CN has a different value proposition than the competition.

Results have been impressive

The chart above depicting CN's share price history should be enough evidence to transcend the "boring business" stigma, but it is only one of several components to CN's plan to maximize shareholder value. Consider this, in Q4 2002, CN's quarterly dividend was around $0.07 per share (split adjusted and converted to USD). That recurring dividend increased to $0.21 per share by 2007 and has increased further to $0.38 per share today. With a payout ratio of just 24%, there's no indication that this dividend won't continue to increase for the foreseeable future.  

An often overlooked way that CN is creating value is through a long-standing share repurchase program. While many companies boast similar programs that in reality only help slow the dilutive effect of stock options, CN's average diluted share count has been declining steadily for years:

CNI Average Diluted Shrs Outs Quarterly data by YCharts

How does CN compare to its peers?

To see how CN sets itself apart from its peers as both a business and a stock, here's a little more detail on CN and its competitors:

  CNI CP UNP NSC CSX
 CAPS rating  5 stars 4 stars 5 stars 5 stars 5 stars
 Share Price   $     95.20  $  110.62  $  131.44  $     65.46  $     20.78
 Market Cap (in billions)   $       41.2  $       19.2  $       61.8  $       20.7  $       21.5
 1 Year Stock Performance  24.2% 59.3% 20.0% -14.2% -9.5%
 5 Year Stock Performance  115.8% 89.9% 138.0% 48.3% 51.4%
 10 Year Stock Performance  596.3% 460.7% 339.2% 239.0% 331.2%
           
 Dividend Yield  1.6% 1.3% 2.1% 3.1% 2.7%
 Payout Ratio  24.0% 32.0% 30.0% 34.0% 29.0%
           
 TTM Operating Margin  36.9% 15.7% 29.9% 25.6% 25.0%
 TTM Price / Earnings          15.50         27.30         16.31         11.92         11.61
 TTM Price / Sales  4.17 3.39 2.97 1.85 1.81
 Price / Book  3.58 3.60 3.16 2.12 2.38
 Debt to Equity Ratio  0.57 0.89 0.49 0.87 1.01
           
 TTM Return on Assets  10.1% 4.7% 8.2% 6.1% 6.3%
 TTM Return on Investment  15.5% 7.0% 13.7% 10.0% 10.8%
           
Source - Motley Fool CAPS 1/16/13


CN is the second largest company in the group above, behind only Union Pacific (NYSE: UNP). Norfolk Southern (NYSE: NSC) and CSX (NYSE: CSX) both provide a higher dividend yield than CN.  Canadian counterpart Canadian Pacific Railway (NYSE: CP) boasts a higher share price return in the past year, while Union Pacific has generated the largest returns over the past five years. Based on the table above, CN is the most expensive company based on price to sales ratio and second most expensive based on price to book. So what makes CN the top 10 stock out of the group?

CN is best in class

The answer relates to the way CN manages its business. A disciplined balance sheet management approach has resulted in CN boasting the lowest payout ratio and second-lowest debt to equity ratio in the group above; this provides maximum opportunity to increase returns to shareholders and provides the flexibility to continue CN's history of successful acquisitions. More importantly, CN's focus on efficiency has led to industry-leading operating margins and tremendous ROA and ROI for a "boring" industry like rail transportation. The result is a highly profitable company with sound financials and growth opportunities bundled together in a mix that differentiates CN from its peers. This strength makes it likely that CN's next five years will look a lot like the past five years, and the combination of stability and performance makes CN not only a great business, but also a top 10 stock.

For more on the Top 10 Stocks, follow the links below:

  1. Apple
  2. Diageo
  3. Coca-Cola
  4. Chipotle Mexican Grill
  5. Costco Wholesale
  6. 3D Systems
  7. Canadian National Railway
    More to come! 


BrewCrewFool owns shares of Canadian National Railway. The Motley Fool recommends Canadian National Railway. Try any of our Foolish newsletter services free for 30 days. 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 Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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