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Union Pacific – Buy/Sell Model - ValueInvestingNow.com
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Union Pacific – Buy/Sell Model

Union Pacific carries the highest price to book ratio among the five Class I Railways. It is about a 1.43 times factor over the next best price to book ratio of CSX at 4.73. Here are the current price to book ratios as of closing on October 22, 2019:

October 22, 2019
.                                                    Market Price       Book Value      Price to Book
Union Pacific                                      $170.46                  $25.13                  6.78
CSX                                                      $71.80                  $15.18                  4.73
Canadian National                                $88.99                  $25.66                  3.46
Norfolk Southern                                $187.54                  $57.65                  3.25
Canadian Pacific                                 $219.37                  $52.02                  4.21
Kansas City Southern                         $145.11                  $49.89                   2.91

In my last article addressing opportunities with railroads, I explained how to build a model to buy and sell stock for Kansas City Southern (KSU). Take note, Union Pacific’s price to book ratio is 2.33 times that of Kansas City Southern. This means the buy/sell model is also different; it is actually almost the exact opposite of KSU’s model. In KSU’s model, the investor looks for opportunity when the price slips more than 5% and then sells once the stock recovers about 12%. With Union Pacific, the investor gets value by waiting on the price to dramatically decrease. I’m talking about more than 15% decreases. Gains are earned once the stock recovers almost to the prior peak. This peak to peak model takes much longer to cycle through with high price to book ratio investments, but the reward is worth the wait.

Let me illustrate by first displaying the last five years of cycling of Union’s stock price. Look at this graph.

Union Pacific

There are actually three cycles that fit this particular set of criteria. On Sept 17, 2018 the price peaks at $164.19. Now the wait begins. Using a 10% decrease, the price drops to $147.77 on 10/22/18. Assuming each share costs $1.00 to buy and the investor spends $1,000, the investor buys 6.7217 shares.

Follow the graph line and you’ll see the price recovers to the peak of $164.19 on 02/12/19. On this day the investor sells and receives $163.19 per share after costs of $1.00 per share. Total amount received equals $1,096.91. Return on the investment after costs is $96.91 and the money was tied up for 114 days. If this is annualized, the yield equals 30.94%.

However, take a look at the gap from February of 2015 to December of 2107. If you follow the criteria for this down/up cycle you get the following:

Buy: On 02/17/15 the stock price peaks at $123.66.  A 10% decrease is $111.29 which happens on 05/11/15. With a $1,000 investment and a transaction fee of $1 per share, the investor buys 8.9055 shares.
Sell: The stock recovers back to $123.66 on 11/27/17, taking 1,014 days to cycle. Dollar yield equals $92.35, interest yield equals 3.325% per year.

As a value investor, that type of yield isn’t going to cut it in terms of a good return on the investment. Naturally, there is dividend yield too. If you figure 1.5% per year, total average annual yield totals 4.8%. This is still not a good return on the investment. So how can the model be improved?

To develop a good model, the reader needs to understand why the down aspect of the cycle is where the real value is earned. Unlike KSU’s model where the down point to buy is 5% less than the peak, with Union Pacific the down point must be greater. In addition, another section explains that buying in a down cycle more than one time is also lucrative to the investor. Finally, the sell point is set and the corresponding results are calculated. The end result is a model that earns a good return for a high price to book ratio investment.

The Down Cycle with High Price to Book Ratio Stocks

As explained in my article, High Price to Book Ratios – Proper Interpretation and Evaluation, strong price to book ratio investments infrequently have deep or extended price depressions. When they do, investors must take advantage of these opportunities. Union Pacific’s financial performance is superior to its comparable competition. To illustrate Union’s financial performance, compare Union to another railroad stock with a similar book value. Let’s see how Union delivers financial performance in comparison.

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