Riding Norfolk Southern to Value

NEW YORK ( TheStreet) -- Before analyzing a company for investment, it's important to have a perspective on how well the business has performed. At at the end of the day, if you are an investor, you are buying the business.

The FAST Graphs presented with this article will focus first on the business behind the stock. The orange line on the graph plots earnings per share since 2001. A quick glance vividly reveals the historical operating record of the company.

Norfolk Southern ( NSC) is one of the nation's premier transportation companies.

This article will reveal the business prospects of Norfolk Southern through the lens of FAST Graphs' fundamentals analyzer software tool. Therefore, it is offered as the first step before a more comprehensive research effort. Our objective is to provide companies that have excellent historical records and appear reasonably priced based on past, present and future data and expectations.

A quick glance at the graph itself and the orange earnings justified valuation line will tell the readers volumes about how well the company has historically been managed and performed as an operating business.

Simply put, the reader should ask whether this example is worthy of a greater investment of their time and effort based on the data as presented and organized. The FAST Graphs' unique advantage is the graphical articulation of the price value proposition.

Earnings determine market price: The following earnings and price correlated FAST Graphs clearly illustrates the importance of earnings. The Earnings Growth Rate Line or True Worth Line (orange line with white triangles) is correlated with the historical stock price line. On graph after graph the lines will move in tandem. If the stock price strays away from the earnings line (over or under), inevitably it will come back to earnings.

Earnings and Price Correlated Fundamentals at a Glance

A quick glance at the historical earnings and price correlated FAST Graphs on Norfolk Southern shows a picture of undervaluation based upon the historical earnings growth rate of 19.7% and a current P/E of 13.7. Analysts are forecasting the earnings growth to continue at about 11%, and when you look at the forecasting graph below, the stock appears overvalued (it's inside of the value corridor of the five orange lines, based on future growth).

Norfolk Southern: Historical Earnings, Price, Dividends and Normal P/E Since 2001

Performance Table

The associated performance results with the earnings and price correlated graph, validates the principles regarding the two components of total return: capital appreciation and dividend income. Dividends are included in the total return calculation and are assumed paid, but not reinvested.

When presented separately like this, the additional rate of return a dividend paying stock produces for shareholders becomes undeniably evident. In addition to the 15.1% annualized ROR (w/o dividend) (green circle), long-term shareholders of Norfolk Southern, assuming an initial investment of $10,000, would have received an additional $8,533.26 in total dividends paid (blue highlighting) that increased their annualized ROR (w/o dividend) from 15.1% to a total annualized ROR plus dividends paid of 16.4% compared with 2.6% in the S&P 500.

The following graph plots the historical P/E ratio (the dark blue line) in conjunction with 10-year Treasury note interest. Notice that the current price earnings ratio on this quality company is as low as it has been since 2001.

A further indication of valuation can be seen by examining a company's current P/S ratio relative to its historical P/S ratio. The current P/S ratio for Norfolk Southern is 2.15, which is historically normal.

Looking to the Future

Extensive research has provided a preponderance of conclusive evidence that future long-term returns are a function of two critical determinants:

1. The rate of change (growth rate) of the company's earnings.

2. The price or valuation you pay to buy those earnings.

Forecasting future earnings growth, bought at sound valuations, is the key to safe, sound and profitable performance.

The Estimated Earnings and Return Calculator Tool is a simple yet powerful resource that empowers the user to calculate and run various investing scenarios that generate precise rate of return potentialities. Thinking the investment through to its logical conclusion is an important component towards making sound and prudent commonsense investing decisions.

The consensus of 30 leading analysts reporting to Capital IQ forecast NSC's long-term earnings growth at 11%. NSC has medium long-term debt at 47% of capital. The railroad is currently trading at a P/E of 13.7, which is inside the value corridor (defined by the five orange lines) of a maximum P/E of 18.

If the earnings materialize as forecast, based upon forecasted earnings growth of 11%, NSC's share price would $146.19 at the end of 2018 (brown circle on EYE Chart), which would represent a 14.5% annual rate of total return which includes dividends paid (yellow highlighting).

Earnings Yield Estimates

Discounted future cash flows: All companies derive their value from the future cash flows (earnings) they are capable of generating for their stakeholders over time. Therefore, because earnings determine market price in the long run, we expect the future earnings of a company to justify the price we pay.

Since all investments potentially compete with all other investments, it is useful to compare investing in any prospective company to that of a comparable investment in low risk Treasury bonds.

Comparing an investment in Norfolk Southern to an equal investment in 10-year Treasury bonds illustrates that the company's expected earnings would be 7.6 (purple circle) times that of the 10-year T-bond interest (see EYE chart below). This is the essence of the importance of proper valuation as a critical investing component.

Summary and Conclusions

This report presented essential fundamentals at a glance illustrating the past and present valuation based on earnings achievements as reported. Future forecasts for earnings growth are based on the consensus of leading analysts. Although with just a quick glance you can know a lot about the company, it's imperative readers conduct their own due diligence in order to validate whether the consensus estimate seems reasonable or not.

At the time of publication the author was long NSC.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.
Charles (Chuck) C. Carnevale is the creator of FAST Graphs.

Chuck has over 43 years of financial experience and is the co-founder of the earnings and price correlated, powerful fundamentals analyzer software tool - FAST Graphs. Chuck holds a Bachelor of Science in Economics and Finance from the University of Tampa. Chuck's work stressing sound valuation has been widely published on numerous financial sites and blogs. Chuck is passionate about spreading the critical message of valuation and prudence in fundamental investing. So much so that regular readers have dubbed him "Mr. Valuation". Chuck is a Veteran of the Vietnam War and was awarded both the Bronze Star and the Vietnam Honor Medal.

Chuck believes that correctly assessing fair value is one of the primary keys of successful stock investing, and he has dedicated his more than 40 years of experience in finance to its pursuit. Chuck agrees with legendary investors such as Warren Buffett, who recognize how important it is for investors in common stocks to possess an intelligent framework for making sound decisions that can keep emotions out of the equation. With making smart stock selections, there is no room for fear and greed.

Chuck was fortunate to learn at an early age that earnings drive long-term stock prices, and that dividends, if any, will be paid out of a company's earnings. This led him to develop FAST Graphs, the fundamentals analyzer software tool that reveals the long-term relationship between a company's earnings and its stock price and dividends over time. Chuck is most interested in the business behind the stock.

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