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Dividends and Earnings Analysis – Railroad Stocks

Dividends and Earnings AnalysisIf a railroad is bent, the train shall turn over; if a man’s character is bent, he shall turn over just like that train. – Mehmet Murat ildan

Dividends and earnings analysis is one of the core requirements of calculating intrinsic value via security analysis. There is a relationship between dividends and earnings; one is a function of the balance sheet, the other is tied directly to the financial performance of the company as reported on the income statement. In general, there must be earnings in order to pay dividends. Investors, especially those holding common stock want rewards for their investment and often, are short-sighted when it comes to receiving dividends. Earnings reflect the power of the company to generate value for the investor. With value investing, the key tenet is to buy a security at as low of a price as allowed by the market and then sell this security at the highest price. In the interim, dividends serve as compensation for a value investor’s patience while waiting on the market price for the security to recover to a reasonable high price.

Railroad stocks are unique. This is one of the few industries whereby all the players have a very similar revenue and cost of production business matrix. There are exactly six publicly traded Class I Railways in North America. All of them have to play by the exact same set of legal compliance requirements; utilize the same physical and technological systems; and cooperate with each other to transport goods across the continent. Interestingly, all six have similar financial characteristics:

  • All generate a profit, the lowest net profit within the group is 22.8%;
  • All have positive operational cash flow and good free cash flow;
  • All issue dividends to their shareholders;
  • All have gross profit margins > 34.5% with the average over 37%;
  • All have low administrative overhead generating high operational profit margins; AND
  • All have similar 10 year growth lines related to share price.

One of the metrics that separates them from one another is their dividends and earnings relationship. Performing a dividends and earnings analysis gives a slight advantage to the value investor over traditional traders and in some cases, if the analysis is done properly and timely, a distinct advantage over professional traders. This particular article is in-depth and educates the investor about this aspect of security analysis for this one industry. The opening section introduces the relationship of dividends and earnings with business in general. There are certain key principles that bind these two financial items together. Understanding this interrelation is key to application of determining value for a company. With this understanding, the second section below develops the railways industry as a whole. It looks back over the last ten years of actual dividends and earnings for all six railroads and analyzes their trends. Here, the impact of this relationship and how it affects the stock market price for the industry as a whole is evaluated.

The final section explores each company individually and explains how this dividend and earnings analysis impacts each company’s respective intrinsic value. The goal is to assist with determining reasonable relationships to the actual stock market price for the company’s shares. The end result is security analysis for each railroad stock as it relates to the dividends and earnings.

Understanding the relationship of dividends and earnings is essential as one of the value investment metrics used by value investors when determining intrinsic value along with expected market highs and lows for a particular stock. 

Dividends and Earnings Analysis – Financial Relationship

Purpose of Earnings

If you read Johnson & Johnson’s credo, it clearly identifies three distinct goals of the company. First, it states that the patients, doctors and nurses are the company’s primary responsibility. Secondly, the credo speaks to employee security. Finally, the credo states that it is the goal of the company to make a profit; but it goes further:

Our final responsibility is to our stockholders. Business must make a sound profit. We must experiment with new ideas. Research must be carried on, innovative programs developed, investments made for the future and mistakes paid for. New equipment must be purchased, new facilities provided and new products launched. Reserves must be created to provide for adverse times. When we operate according to these principles, the stockholders should realize a fair return.

Notice how Johnson & Johnson’s credo explains how the profits are to be used. There must be investments made for the future and to pay for mistakes. Furthermore, tangible fixed assets must be acquired to fulfill the need to innovate and conduct research.

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