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Full Steam Ahead for Railroad Stocks

It’s not quite the 1830s, but a railroad boom in 2013 is creating quite a tailwind for major U.S. rail stocks Union Pacific (NYSE:UNP), Norfolk Southern (NYSE:NSC) and CSX Corp. (NYSE:CSX). Union Pacific stock is up over 30% in the past 12 months to roughly double the S&P 500, and more recently CSX and Norfolk Southern have added gains of more than 20% since Jan. 1.

Even some railroad stocks to the north like Canadian Pacific (NYSE:CP) are getting in on the act; CP stock is up more than 60% in the past 12 months.

So what gives? Why are railroad stocks steaming ahead — and can investors still load up on the profits?

A Cyclical Story

For starters, it’s important to acknowledge that railroads are part of a bigger story with cyclical investments this year. The iShares Dow Jones Transportation Average ETF (NYSE:IYT), an indexed fund tied to the benchmark, is up 18% so far in 2012. And while its outperformance has started to waver, those kinds of gains are hard to argue with.

Sure, certain components have signaled trouble — including FedEx (NYSE:FDX), which tumbled big-time in March thanks to an ugly earnings miss — but by and large the group is up strongly. Take a look as some choice gainers:

  • Barge operator Kirby (NYSE:KEX) is up 23% YTD
  • Trucker J.B. Hunt (NASDAQ:JBHT) is up 24% YTD
  • Airline Delta (NYSE:DAL) is up 40% YTD

And for the record, domestic rail stocks UNP, NSC and CSX are all part of the Transports, too.

The common theme here is that the U.S. economy continues to get its swagger back and investors are optimistic about growth prospects for the second half of the year and into 2014. That means a general boost for all cyclical stocks that will keep up as long as the optimism over the economic recovery does.

Railroads Have an Edge

The group of stocks that make up the Dow Transports have a lot in common, since all shippers in this group are tightly correlated with broader freight trends. Obviously more orders for inventory from retailers or raw materials from manufacturers mean more sales.

But while the economy itself dictates much of the top line, the bottom line is what gives railroad stocks an edge over their compatriots.

This recent passage from The Wall Street Journal sums things up pretty well:

“North America’s major freight railroads are in the midst of a building boom unlike anything since the industry’s Gilded Age heyday in the 19th century — this year pouring $14 billion into rail yards, refueling stations, additional track. With enhanced speed and efficiency, rail is fast becoming a dominant player in the nation’s commercial transport system and a vital cog in its economic recovery.”

Compare that with the disarray of the airline industry, which only manages to find gains through consolidation like the planned purchase of now-bankrupt American Airlines by U.S. Airways Group (NYSE:LCC) or through sneaky add-on charges like bag fees.

The fact that railroads are investing in growth now will result in bigger returns down the road through increased operational efficiencies and profitability.

Furthermore, while there have been some conflicting data points elsewhere from transports (again, FedEx earnings), there have been very encouraging rail data. One measure of rail traffic reached its highest 12-week moving average since 2011 in early March … and while subsequent weeks haven’t been as impressive, total rail traffic for the first 12 weeks of 2013 remains up slightly over last year.

Throw in 2% dividends across the board for Union Pacific, Norfolk Southern and CSX and you have a pretty compelling case for a long-term bet on the sector.

If the economy continues to look up, expect railroad stocks to lead the charge.

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Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.

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