Railroad Stock – Discovering Opportunities
The fundamental rule with investing is to buy low and sell high. Unfortunately, an investor doesn’t know when either a low or a high price is going to happen. What if the price drops for the stock and you buy it and then it keeps dropping? When do you sell? Nobody has a crystal ball that can foretell the future. You have to base your decisions on facts and the most likely outcomes based on the historical behavior of the investment.
One of the benefits of railroad stocks is the downside risk. When the stock’s share price decreases, it is unlikely it will continuously fall. The business ratios used in this industry assist in understanding how far a share price can fall. The further the price decreases, the more lucrative the investment becomes. Thus, the market – other buyer are enticed to purchase the stock due to the desirable attributes of the stock. The first section below covers this particular aspect of the share price decreasing.
On the flip side are increases in share price. How does an investor know when to sell? If you sell early, you miss out on any additional increases in share price that can add dramatically to your gain upon the sale of the stock. With railroad stock, the historical pattern has rarely wavered from a continuously increasing trend line. The key is to be patient. Yes, the longer it takes to recover and generate gains for the investor, the lower the yield for the investor. Never look at this in isolation; it’s about Bernoulli’s Law (Law of Large Numbers). In the long run, if you adhere to the model, you will make positive gains, I’m talking about 18 to 30% year on year, not sudden 40 to 50% gains. The second section explores triggers to sell the stock; how do you know when it’s time?
This is where railroad stocks are ideal for the application of this concept. As stated in the prior article in this series, railroad stocks are solid and steady investments. There are six companies publicly traded with sufficient revenue and similar operational systems for comparative purposes. In addition, each company provides a plethora of information to assist the investor in understanding the downside risk and of course the pattern and underlying circumstances that push upward on the share price. The final section illustrates the development of a model. In this case, I use Kansas City Southern’s history and walk the investor through the steps necessary to develop the decision model.
Before I begin, I’m going to reiterate my statement from the first two articles in this series: I have no financial investment in railroad stocks, this series is designed to test a concept I developed in my book, Value Investing with Business Ratios. The only financial results, benefit to me, of writing this series are as follows:
- I get a little bit of money from the advertising on this site, i.e. when you read this article I get a portion of a penny from the advertiser.
- Secondly, you may find this interesting and want to buy my book, wonderful; the link is on the home page.
- My comments, thoughts etc. have little to no effect on the market price of railroad investments for several reasons: A) I’m not a professional investor, B) Volume of shares bought/sold each day are in the millions, and C) Institutional investors are the ones that really move the stock’s price, not me.
Railroad Stocks – Limited Downside Risk
One ratio stands out in determining downside risk for stock. It is the price to book ratio. The price to book ratio compares the market price for a share of stock against the book value of that same stock. The most important value with this ratio is the actual book value. It is important to understand that book values can be solid; assume the only asset is cash, or risky; assume the only assets are junk bonds.