I like railroads as an investment for the following reasons:

• Simple to understand - railroads move heavy shit from point to point;
• Macro-economic effects on railroads are easy to figure out - when the economy is good, people are shipping stuff, when it crashes, volume goes down;
• Efficiency, railroads use substantially less fuel to transport goods than trucks;
• Not affected by increasing traffic congestion; and
• There are only six Class I railroads in North America, making it simple to compare them.

Operating ratio is a key metric of railroad performance. It is basically a measure of profitability and shows the percentage of revenue used to operate the railroad. A lower operating ratio is better, as more revenue is falling to the bottom line or available to reinvest in the business. Over time, if the operating ratio is decreasing, the railroad is increasing profits. Railroads with lower operating ratios have more cash to reinvest in the business or return to shareholders in the form of dividends and buy backs. They also earn more for each additional dollar in revenue.

Despite being such an important measure, the operating ratio is easy to calculate. The operating ratio is simply operating expenses divided by revenue. Both items can be found in the annual report under the Consolidated Statement of Income, Consolidated Income Statements, or similar. This is generally at the back of the report to discourage investors from actually reading it.

A few conclusions can be drawn from the above table. First, Canadian National (CNI) has the lowest operating ratio, which is a sign of effective management. Second, Norfolk Southern (NSC) shows the most improvement over the five year average, a decrease of 11.9 points. This implies management has been successful at controlling costs and increasing efficiency. Additionally, NSC has the second best operating ratio of the railroads compared. Union Pacific (UNP) has the highest operating ratio, a sign of poor management. Their operating ratio, while improving on a year over year basis, is also above the five year average. This means management is getting worse over time. While CSX currently has the second worst operating ratio, they have the second highest decrease over the five year average at 10.1 points. For the industry as a whole, operating ratios declined from 2005 to 2006 and were well below the 2001 - 2005 average.

While important, the operating ratio is not the only measure of railroad performance. Several more will be posted in the future. Check out the next article in the series, Railroad Performance Measures: Yield.

Since this shit is boring, a little inspiration is in order:

notes:

Annual reports are available at the following web addresses:

• BNSF Annual Reports
• Canadian National Annual Reports
• Canadian Pacific Annual Reports
• CSX Annual Reports
• Norfolk Southern Annual Reports
• Union Pacific Annual Reports