Canadian Pacific<\/span><\/strong><\/a>, notice how their’s is much higher than all the other railroads. Management is stating to readers of financial statements that their administrative overhead is a mere 1.76% on every dollar of revenue. For me, this is difficult to believe. You rarely see administrative costs less than 3% of sales. Therefore, I looked at their income statement and discovered the following. Their SG&A expense is $137 Million on $7.8 Billion in revenue. Whereas Canadian National had $936 Million on $14.9 Billion (double the sales of Canadian Pacific) in revenue. How can this be? Companies this size should not have 3 times as many administrative personnel or extravagant marketing budgets. How can this be the case? The answer: cost shifting.<\/span><\/p>\nCost shifting means that the particular entity defines certain costs into different pools. It is conceivable that Canadian Pacific defines certain admin costs as costs of production thus having a lower gross profit margin over Canadian National.<\/span><\/p>\nThe key though is the operational profit margin for the particular investment, what did they earn before taxes, not necessarily gross profit margin. Thus, an investor needs to be careful and monitor margins and make sure they understand how the particular entity defines the respected terms used.<\/span><\/p>\nI would imagine many of you are saying, why not just use net profit margin as the best financial ratio. The answer is simple, tax rates for the respective entities are different and lack consistency from year to year. Both Canadian National and Canadian Pacific pay both Canadian and US taxes whereas the other four mostly just pay US taxes. Furthermore, the tax rates change from year to year. As evidence, look at Canadian Pacific again, it looks like they pay around 8.78% on the dollar of revenue for taxes.<\/span><\/p>\nCanadian National paid or deferred $1.2 Billion on $14.9 Billion of revenue or 8.05% of sales. Canadian Pacific paid $706 Million on $7.8 Billion in revenue or about 9.05%. Thus, taxes do impact the final outcome; not significantly, but enough to make a difference.<\/span><\/p>\nOperational Cash Flow Per Share<\/span><\/strong><\/h2>\nThe second most important ratio to me is the ability of a company to generate cash from its operations. To compute this, an investor first acquires the operational cash flow per share and compares this to other similar investments. The table above shows a vast discrepancy between the railroad operations. Canadian Pacific generates $21 per share whereas CSX only generates $6 per share. How do you compare them? The answer is with the price to cash flow ratio. This compares the share price between the two entities against their respective ability to generate cash per share. The lower the value, the better the ability for the railroad company to generate cash per $1 of market price per share. Ideal values are below 10 when referring to any of the S&P 500 stocks. Ten to fifteen are the most common values for the S&P 500. The table reveals that Canadian National with an 11.47 is the best value among the group. Since Union Pacific is often considered the standard bearer for the railroad industry (Union Pacific has a long history of profitability and stable revenues, costs etc.; also it generates the most sales among the railroad investments at just over $21 Billion), it has a high 15:1 price to cash flow ratio. Yes, I do see that Kansas City has a 15.83 price to cash flow ratio but Kansas City reported an unusual event during 2019 affecting their financial results and of course the corresponding ratios. Thus I defer to Union Pacific for comparison purposes.<\/span><\/p>\nContinuing with Union as a comparative, McDonald’s sales are also just over $21 Billion per year; but because McDonald’s has a market capitalization of $50 Billion more than Union, McDonald’s is one of the DOW Jones 30 investments and Union is not.\u00a0 What is interesting is McDonald’s price to cash flow ratio is just over 18:1. This informs an investor that all of the railroad companies above are good investments even at their current high prices.<\/span><\/p>\nBut this is about value investing. That model requires us to buy when there is a drop in value, usually anytime there is more than a 9% decrease from a peak price. Buy the stock and simply wait for it to return to the peak price as the history of the railroad investments have shown continuous market value increases over time due to their stability and the respective industry’s position in the transportation sector.<\/span><\/p>\n
![\"Railroad](\"https:\/\/businessecon.org\/wp-content\/uploads\/Railroad-Fund-Analysis-02-15-2020-GIF-scaled.gif\")
<\/span><\/p>\n